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The NAHB Homebuilders Index was released earlier this week and predictably was weaker than expected.

Dismal.com reported:

Homebuilder optimism decreased three points to 36 in March. Overall, the index is down noticeably in every component except traffic of prospective buyers, which dropped from 29 to 28. However, 28 is an exceedingly low number and indicates the housing market may represent a significant drag on the economy this spring, especially since the Fed does not seem willing to adjust the interest rate target.

Now I cannot say I did not see this coming. While I was shopping for a home this spring, I was inundated with builder inquires with regards to a home I was gong to build. I could not get these inquires a few years ago but now I was getting four or five calls a week from desperate builders.

Also, many subdivision homes are being built, but there's not much traffic for these houses. I would hazard a guess that this index is more panic than anything – nothing changed fundamentally in the market – as the builders expected people to come (once they built) and that has not occurred. The problem for new home sales is that the builders are stuck with homes – something they did not bank on when building started. This could cause further price pressure for homes in general.

So is this priced into the homebuilders stocks? Well, the section of homebuilders I watch are at their most oversold point since 1990, using two measures of the RSI along with the R% model. That happened to be amidst the downturn from the 1980’s housing boom. From there, these names accelerated to the upside. That decline occurred on bad news (as it was pretty bad back then) and the current one is on the prospect of bad news.

With sellers more willing to drop prices, this could break the log jam within the market. It doesn't mean that the housing markets will explode to the upside. However, it does mean that stability is starting to form.

So if I see some stability, how do I monetize this? Well, in looking to buy these stocks, earnings wise I am a bit scared. Things are just flat out ugly. Last summer when these stocks bottomed, the PE multiples were in the single digits. At the moment, they are at least double that in many cases so buying these stocks based on their value is not an option.

In terms of earnings momentum, only one of the stocks in my sector, Hovnanian (NYSE:HOV), is showing positive momentum. Some stocks have negative fair values. It is just an ugly situation.

But perhaps this is as bad as it gets. The NAHB was weak. Housing sales numbers will be weak. Earnings “suck” according to some CEOs in this sector and builders are panicking. Is this the type of environment when you buy? I think we are getting close. However, I am not sure if it will be a pinpoint turn so I put a very small 25% of a normal position to work on Monday in one name: HOV.

HOV is not a cheap stock. It's expected to earn nothing in 2007 and $1.41 in 2008. I think they can beat both as the environment is just not as bad as these earnings expectations illustrate. The chart shows support right around the 25 level where previous bounce have occurred. While fair value is negative, it is turning upward now and earnings momentum is positive.

This is clearly a speculative play but I like the small risk reward as I am only putting 25% of my normal position to work. We’ll see what happens.

HOV 1-yr chart:

Source: Hovnanian: Housing Slump Buy