Get Ready For The Next Housing Stock Plunge

Includes: HOV, IYR, XHB
by: Dave Kranzler

I wrote an article the other day in which I suggested that the housing stocks could be safely shorted on the bounce from Hovnanian's (NYSE:HOV) earnings report because the fundamentals and technicals were deteriorating. You can read review that article here: Sell This Bounce. I also suggested that if you entered a short-sell trade on the day my piece was published, that you might be wrong for a couple days. The housing stocks (DJUSHB) bounced for one and half trading sessions and have now "rolled over" to resume another move to lower lows. Let me explain.

On Wednesday, the Mortgage Bankers Association released their weekly mortgage (refinance + purchase) index. Overall applications on a seasonally adjusted basis were down 13.5% week to week. On an unadjusted basis the index declined 23%. The key component that is germane to home sales is that the seasonally adjusted purchase index dropped 2.7%. That was week to week. Year over year it dropped 3%. This is not what is supposed to happen to a market that is promoted as being in a recovery. In fact, here's a chart of the purchase index from 2006 to present (, edit in red is mine):

(Click to enlarge)

Where's the recovery? Please note that this data is seasonally adjusted, which should somewhat "cleanse" the seasonal affects from the data. Briefly, during this so-called recovery the purchase index at its peak only clawed back to 48% of the level it achieved during the housing bubble. Currently the purchase index is now dropping sharply and has been dropping sharply all summer, something which should not be occurring during the peak seasonal selling period. What's even more troubling about this is that banks have become more lenient in terms approving mortgage borrowers who are purchasing homes: JP Morgan Removes Lending Barriers. This should be stimulating purchase applications but it's not.

Thus from a fundamental perspective, it would appear that home sales are literally starting to collapse. Technically this is being reflected in the daily chart of the DJUSHB:

(Click to enlarge)

As you can see, the DJUSHB had a day and a half bounce since I published my short recommendation. Over that period the index bounced from 415 up to 440. But as soon as it tagged 440 yesterday, it sold off hard into the close. I've circled the candle stick from two days that shows the reversal. This "gravestone doji" can be a very bearish signal if the next couple of days confirm the reversal/sell-off, which they have. The other red circle to the upper left of Wednesday's circle shows another instance when a 2-day bounce with same candlestick formation led to significant decline.

From this chart you can also see the RSI momentum signal has hit a "resistance" level and rolled over. This confirms the fact that the index itself, while briefly popping over the 50 dma, has reversed and lost this key moving average level. Both signals are quite bearish. Finally, you can see from the white circle at the bottom that the brief bounce in the index was accompanied by much lower volume than the preceding multi-day decline. I have to say, if I traded strictly on chart technicals (which I don't) I would be piling into the short side with leverage.

In summary, both the additional fundamental data released this week and the multiple technical signals of the DJUSHB confirm my view that the housing stocks can be shorted here with confidence. One more quick point on fundamentals, retail sales for August were released this morning and showed a 6.5% decline for building materials from July to August. Note that this number is not adjusted for inflation, so the real volume decline was likely even greater. In my article earlier this week, which I linked in the first paragraph, I listed several ways in which to express the "short" view of this sector. I still like every idea presented.

Disclosure: I am short DHI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.