Housing Stocks: Watching the RSI

The U.S. housing industry is in recession, and buyers are delaying purchases. There are apparently 870,000 unoccupied homes that must be cleared before pricing and unit demand will accelerate.

The U.S. Homebuilding Equity Research Group of UBS working with the company’s Chief U.S. Economist has produced an important study, which was published Nov 6. Download UBS Assessment of U.S. Housing Market.

In this report, UBS introduces a new proprietary “Housing Signposts” forecasting tool, which quantifies the number of new homes needed annually as 1.55 million in 2007 (revised down from their previous forecast of 1.73 million) and 1.65 million in 2008 (revised down from their previous forecast of 1.80 million).

This is a netting of the 2.0 million demand less a working down of the available over-supply.

In addition, UBS is forecasting a further 10 pct decline in home prices over the next 12 months, which is required to remove the glut after a recent 4 pct price drop off peak prices has not solved the task.

The homebuilding industry has been doing all it can to cut back, which includes cutting selling prices on housing inventory, selling lots and in fact walking away from out-of-the-money option deposits.

The financial impact on earnings, however, will balloon. For instance, where industry EPS declined 22 pct in 2006, UBS is now forecasting a further decline of 46 pct in 2007, and a 28 pct decline in top line revenue.

Former Fed Chairman Alan Greenspan told an audience that the industry issues have reached the cycle bottom, but some of the homebuilders, like Toll Brothers, have denied that, and this UBS research study confirms their expectations.

Interestingly, UBS rates Toll Brothers (NYSE: TOL) a Buy with a 12-month Price Target of $37 based on a calendar year 2007 estimated EPS multiple of 11.

On Aug. 22, I wrote about the industry and TOL in my article entitled “A bubble-popping case study”.

I wrote in that article: “Fast forward to today(TOL at $24.77): the Monthly RSI is well below 30 for these companies, but the Weekly and Daily RSI levels are way too high to consider buying. Would I buy at some point when the M-W-D RSI 7 are all below 30? Yes, but only for a short-term trade when I see other Consumer Cyclical stocks also commencing rallies at the same time.”

On Jun. 7, I wrote a piece called “Are home-builders now a Buy?” In it, I went through an extensive review of the RSI, which showed these RSI levels for the Monthly-Weekly-Daily at extreme lows (averaging 26.4-16.7-16.8 for nine major builders).

In that instructive article, I opined: “So, as for me, I’m looking ahead to a severe equity market shake-out. If so, one of the drivers will likely be rising interest rates or at the least liquidity issues. These are factors that will likely drive the share prices of the home-builders lower – to a point they become even more over-sold. There will be a time soon – because we are in the Accumulation one – when buying does make sense. Wait for it. The RSI numbers will show it. There is no need to out-think the market. Let the market come to you. Because of this over-sold situation I expect to see this group of stocks to be among the leaders of the next bull market.”

Two points in follow-up:

(i) I was so focussed on the housing industry crisis during the summer that I was looking past the cycle bottoming that RSI was screaming was happening. As you know, I didn’t miss the cycle bottom in July in technology because I gave you twenty (20) great stocks at that bottom, and I saw the RSI numbers also bottoming for the Home-Builders too – lower even than on June 6. But, for me to have called a Buy – even a trading Buy in the housing stocks when they were at lower prices – especially in a public blog where I take myself seriously sometimes – I was waiting for the full consumer cyclical sector to bottom out. I didn’t see that happen and so I figured that the next cycle wave in the broad market would take prices of the homebuilders to an even lower low. So, maybe we’ve already had it; maybe not.

(ii) There is no doubt in my mind, however, that I proved to most of you with this real-time case study that the RSI indicator trading methodology is a worthy tool. You know by now that if you can simply pick high-quality, well-managed companies and buy them when the whole market, but especially when the sector and sub-sector is at a cycle low (Cara’s Accumulation Zone) and sell them at cycle highs (Cara’s Distribution Zone), you will be amazed at your portfolio performance. It takes discipline because you are going to have to buy when most traders are following the noise of the market telling them to sell, and you will have to sell when that noise returns in reverse. You’ll never get the absolute low or high, but you will be a winner.

This is an important point. People like to all me eccentric and arrogant. I’m really neither, but I certainly understand why many people think that way. It’s just that I understand trading prices, and I have a discipline that is permanent. I walk on solid ground, knowing the journey starts here and ends there, over difficult terrain where most get lost, except I have a road-map imprinted in my brain.

So have a look at the U.S. home-builders RSI table and charts for today, and compare them to June 6, at a point the market was within days of a cycle bottom for this group. Remember what you were hearing and reading from experts, and then from me.

ADDENDUM:

Download Merrill Lynch analysis (Nov. 2) of the current housing industry crisis in the U.S. Their message: U.S. home-builders will be impaired in 2007-8, but not go bankrupt.

Download Credit Suisse detailed report on U.S. housing market (Nov. 7). Their message is much the same: the bottom is still to come. As they say: "inventory is well beyond market perceptions and misinterpretations of seasonal trends could point to another leg down in 2007 that results in profit pressures beyond embedded expectations."

The home-builder group is an important sub-sector in the U.S. equity market for many reasons. I am hoping that readers contribute ongoing comments to my articles (and research) on this particular theme because our collective wisdom could pay off handsomely. This is one part of the market where well-timed entry positions in the stocks of the best quality companies will produce very high financial returns.

Comments

[julian albert:]

what charts or service provides the detail on rsi you show.. the stockcharts i use only show rsi 14 and it is a bit diffucult to observe the change in direction [e-mail]

2006 Dec 25 10:17 PM