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I made the case last month that the homebuilders, technically, were very strong. They had the bulls pushing the right buttons with the likes of PHM, TOL and BZH moving higher. As a whole, the sector was chugging higher as momentum across the complex forced the shorts to duck and cover (or is that cover and run?). This occurred all while earnings continued to erode and while the MBA mortgage application index rose and started to collapse.

Finally, sales data from both New and Existing Home sales was mediocre though the median price of both was moving up. Is the action in the trade of these names saying the worst is over?

In looking at the models for the companies I am following from this sector, the story is pretty much the same. Momentum continues up in a positive fashion. That has been the case for the most part since the middle of September. Opposite this is the earnings trend of the sector which is extremely weak – probably the worst of the year thus far. Valuation wise, the sector has no growth and rising PEs which is a danger to the bullish case – especially if rates continue to rise like I expect. The question then is this: Can it continue? To answer that question, let’s look at the charts.

The Philly Homebuilder Index, which encompasses the names that I am following in this sector, has been on a roll higher since hitting the lows last year. With each pause, the shorts run for the hills and the index moves even higher. With the bounce off the 230 level, the HGX established a major support returning to a prior trading range in the process. The top of this trading range stands near the 270 level which would represent another meaningful move by the index as a whole from the 250s at the moment. Wouldn’t it be remarkable if these names rallied past the 270 level, in the face of a very bad housing market!

How ludicrous does that sound! The housing stocks are rallying in the face of a very weak market. Normally this is a bullish development. However, when a given market or security bottoms, it normally does not return to the previous highs without support from the fundamentals. This tells me then that this move is long in the tooth…that is long in the tooth if the earnings picture does not follow through. The fact that the index is now only about 16% from the highs supports this case. Also, one more point. From a Fibonacci point of few, 270 would be the 62% retracement level from the 190 lows. Normally a rally will stall there and then head back to the downside…further support that the rally is near a top.

A Tight Fed Does Not Help
One model that I have not touched on in the past is my Fed Funds Fair Value indicator – an indicator I use to measure whether the Fed is tight or easy with the funds target. For much of the past four years, the Fed was easy allowing assets to rise both domestically but also globally. Since Christmas, this indicator has turned down rather aggressively though as recent inflation data has dipped and crude prices sink. Currently, fair value for the funds target has fallen to 5.08% down from the 5.45% level seen about 3 months ago. This means the Fed is now in restrictive mode. The last time this occurred was in 2000 and the economy promptly dived lower as conditions worsened.

But before this happened in 2000, the overly tight Fed sent the long end of the curve, 10s and 30s, below the 13 week bill. This development, combined with the pretentious election (Bush v Gore) and the busting stock market bubble, sent the economy into the toilet over the next few years. A development like this would be an extreme negative for this sector only because the consumer would suffer (lower rates would help a bit but I think the stretched consumer would need much lower rates). Is it a reasonable expectation? I would rate it as a lower probability event at this juncture. But it is out there!

One more fact to consider is this. On the long term chart, when the short 13 week bill turned down four months ago, these names all found a bottom and started to rally. As the Fed gets pushed back into equation, as the IRX is signaling, perhaps this puts an end to the rally in these stocks. If not, it will be a headwind.

So, What Should I be Doing?
First and foremost, I would not be long any of these names. My investing approach uses both earnings growth and quantitative metrics. Given the weak growth picture at the moment plus the forward expectations in the marketplace for earnings, I would not buy these names outright. If I were looking at technicals only, some of these stocks look promising. But “promising” is not enough for me to add to the portfolio. Here is a rundown of the sector.

Hovnanian (NYSE:HOV)
HOV has been very volatile over the past few weeks. Taking part in the bid for Equity Office Properties, investors seem to be reluctant to take the stock higher even though the other names I follow in this sector are all on the move. On the earnings side, the picture is not pretty but in a way, is improving. Forward numbers into next year are looking for 15% growth. That is expensive though, given that on a PEG basis, the stock is trading at 1.78x growth. Technically, selling pressure seems to be returning and bouncing off support. An extreme move was registered in my models at the beginning of December and the stock has not returned to the level since. Momentum is now unwinding in bearish fashion as well. Based on this evidence, I would be short HOV with support coming from an expensive earnings and weak technicals.

Pulte Homes (NYSE:PHM)
Pulte is a risky position to own on the long side. Growth on a trailing basis using the 2007 numbers is expected to fall 43%. Using the 2007 number, PHM is trading at 21x earnings which is very high for a company that is not growing. Technically, buying and selling pressure models are stuck in neutral. Momentum models have been on the rise supporting this most recent move and it has not been extreme in any way – thus no opportunities. The stock looks like it wants to march up to 37 but I would imagine it won’t be easy given the backdrop. I would not own this name on either the short or long side because of many conflicting signals.

Beazer Homes (NYSE:BZH)

Beazer is on the move though has encountered a good deal of resistance around 46. Today BZH finally broke past this level and momentum appears to be picking up a bit after doing nothing since the break higher in early December. The long term model argues for neutrality as both buying and selling pressure are mute. Earnings wise, the company is trading at 19x 2007 numbers but forward growth into 2008, using consensus figures is expected to be 56% (I am doing work on this). The earnings trend is pretty beat up and very weak at the moment so I imagine this acts as a small drag on things. Historically the 30 month moving average has capped the stock or supported it on the way down. At the moment, it is a level of resistance. With the forward earnings picture looking particularly strong, I would not be short this company. In fact, I would look for a chance to get long.

Toll Brothers (NYSE:TOL)
TOL has been one of the better stocks in this sector showing rising momentum since the middle of October. The stock really has not made much headway overall (trading about inline with the market) but it has been moving up nonetheless. The long term trend now points higher as well after being down since November of last year. On the chart, TOL bounced nicely off the 65 month MA – an MA that has served as a support and resistance level for many of these stocks. Not all is positive though as buying pressure is not breaking out while selling pressure unwinds. The earnings picture is ugly with growth falling year over year and expected to do so into next year. The stock is trading at 19x earnings with -10% growth. Based on an extreme move at the beginning of the month, I would be short this stock (and underwater for that matter) but only a half position given the upward rising trend of the stock.

MDC Holdings (NYSE:MDC)
MDC is an interesting story – one that I profiled about three months ago when the monthly chart put in a nice reversal off the lows. Buoyed at the time by private equity talk, MDC shot up. It took a few weeks off and is now accelerating again to the upside after bouncing off the 65 week EMA. Momentum turned to the positive side in November (though changed trend in September. Now if only the earnings picture backed up this move! Earnings are ugly on a forward and trailing basis (though this is not much different than the rest of the stocks here). But the chart just looks very strong. Unfortunately, one end of my model argues that I cannot own the stock so I will not but the trend looks higher at the moment.

Ryland Group (NYSE:RYL)
Ryland is much like MDC with a basing formation on the long term trend and then bouncing strong to the upside over the past few weeks. This move looks like it could take the stock back into the 60s before it runs into the bottom of its previous range. The problem(s) with owning this stock though are weak outlook on forward earnings and the lack of buying pressure (vs. unwinding selling pressure) on the long term chart. Add in the fact that this stock bounced at the moment the short rate 13 week bill turned down (and is now turning back up), that could cap the stock going forward. I would be short this stock due to the extreme move at the early part of December – obviously under water at this point.

American Standard (ASD)
I realize that ASD is not a homebuilder but it is related which is why it is included in this section. The stock is currently in breakout mode on the long term chart. This move measures to the 55 level if the current levels are held into month end. The move up has not been extreme and has support from the long term trend. With a PE of 15x earnings and forward growth of 15%, the stock is trading cheap in my opinion. The one concern I have is the earnings trend which continues lower from a few years ago – nothing extreme but enough to consider in terms of news that could hold this tock back. I would be long ASD looking for the 55 level in the next 12 to 18 months.

Centex (CTX)
CTX saw its earnings fall off a cliff this past year and the market expects them to growth earnings solidly into next year (though way off the previous levels earlier in the decade). The problem is that earnings are not supportive of a rise here and the trade following the breakout in momentum from September has begun to level off. Based on the fact that the long term trend remains down, selling pressure is now ticking up and earnings are essentially showing negative growth over a 2 year period, I would have looked for a shorting opportunity and got one earlier in the month. Thus I would be short CTX.

Lennar (NYSE:LEN)
Looking at LEN is like looking at CTX. The two look exactly alike and are trading in very similar fashion. The difference in this picture is that I am not sure about this stock. The community expects ok growth into next year and the trends look like they are moving up which should continue to dive the stock. Buying pressure and selling pressure though are stalled and momentum is on pause. Thus, I really don’t have a clue which way this stock is going. Neutral long term readings; weak earnings and pausing momentum. I guess I am neutral.

KB Homes (NYSE:KBH)
Everything I said about LEN can be said about KBH EXCEPT that the overall trend remains lower. Also momentum wants to take this stock lower but the shorts keep bringing it higher. Selling pressure is turning back up and if buying pressure falls back further, we could see this stock break down a bit more. However, I think the momentum may win out here for the short term so I would not attempt a short at this point. The earnings picture gives me support to short the stock but at the moment, there have not been any opportunities that are “safe”

Positions that would be Long: ASD – Short: HOV, TOL, RYL, CTX
Positions I would close or open: None
Stocks Monitored in the Universe: PHM, BZH, HOV, TOL, MDC, RYL, ASD, CTX, LEN, KBH

Source: Homebuilder Stocks: Is the Worst Over?