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The market’s rally over the last six months has benefited some of the most speculative stocks more than higher-quality stocks. This has been increasingly apparent recently as speculators have bid up extremely questionable firms such as AIG (NYSE:AIG) and Fannie (FNM)/Freddie (FRE) (which Bloomberg’s Johnathan Weil calls the $260 billion black hole). Homebuilders stocks have also been a huge benefactor of this trend, even though their fundamentals still signal deep and long-lasting challenges are still ahead. As regular readers will surely recall, we have consistently advocated sticking with high-quality stocks even though the economy has stepped back from the edge of the abyss.

Hovnanian Enterprises (NYSE:HOV) reported earnings on Wednesday that were worse than analysts had expected, and showed that the general improvement in the housing market does not necessarily help homebuilders. The results were expected to be poor, with analysts estimates calling for a loss of about $1.52, but the report was actually worse coming in at a loss of $2.16. The homebuilder’s performance was hamstrung by a write off of more than $105 million on land investments, but there were some encouraging signs like a reduction in debt and better cancellation rates.HOV

Amazingly, this is the 12th straight quarterly loss for the beleaguered homebuilder. Clearly, it has not been the fundamental strength that has propelled HOV to a more than 400% increase since the stock bottomed. This performance can instead be attributed to two factors; one, the price was oversold to the point it was almost priced for bankruptcy in March, and secondly, there has been a general feeling that the housing market and the economy have seen the worst.

While the economy may have turned a corner, that does not necessarily mean that homebuilders have. There is a shrinking but still sizable overhang of available homes on the market, and foreclosures have not abated even as other economic indicators signal a stabilization. Furthermore, residential mortgages in delinquency reached a record height just yesterday. There are also a massive number of mortgage resets set to come due for the rest of 2009 and into 2010, which could add additional pressure to already stretched “homeowners”. This situation will take time to be resolved, and that could be time that some of the weakest homebuilders can ill afford.

We have downgraded Hovnanian as of this week’s report to Overvalued from Fairly Valued. We issued this rating as of Friday’s close, so it actually had nothing to do with the disappointing quarterly performance, but it had everything to do with the stock’s excessive valuation. According to consensus full year estimates, this company should lose close to $8 per share, and revenue is down by nearly half from a year ago. The shareholders equity portion of the balance sheet has finally turned into a deficit, which should be a major red flag to any investors or even speculators. There is little encouraging about the performance of the company or the marcoeconomic environment to make us become bullish. No doubt speculators abide by a different set of rules, but this stock is simply not fit for investment.

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Source: Hovnanian: Homebuilders Still Crippled by Supply