The Housing Market Recovery Catches Shorts Flat-Footed

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Includes: HD, LEN, LL, LOW, NVR, SPY, TOL, TREX
by: Todd Campbell

The housing market is getting interesting again. Housing stocks have had their fair share of fits and starts over the past few years. But something has changed over the past few months. Investors are starting to believe the turn in construction is upon us, and are bidding shares higher.

Housing data is increasingly encouraging.

The data support the idea we've seen the worst housing has to offer. Housing starts were up double digit percentages in December, rising 24.9% year-over-year. A mild winter - absent severe storms - has helped. Building permits were also strong, increasing 7.8% versus last year. And, single family authorizations rose by 1.8% in December from November.

A short squeeze is providing a floor underneath shares.

Companies supplying goods to home owners and contractors, such as Home Depot (NYSE:HD), Lowe's (NYSE:LOW) and Lumber Liquidators (NYSE:LL), which still has 12.6 days to cover short, have been trending up since fall. Even decking company Trex (NYSE:TREX), with an eye popping 19.6 days to cover short, is working its way higher. A sign of stronger demand reflects growing optimism at the local level, reinforced by a 4.6% lift in construction supply production in December.

More broadly, shares of residential construction companies including NVR Corp (NYSE:NVR), Toll Brothers (NYSE:TOL) and Lennar (NYSE:LEN) are heading higher too, rising 35%, 76% and 87% from their lows this past fall - far better than the 23% return in the S&P 500 ETF (NYSEARCA:SPY). Shares of Lennar are trading at their highest since 2008 and similarly, NVR and Toll are challenging the high end of their multi-year ranges.

One reason behind the move is likely the complacent pessimism reflected by short sellers. Despite these moves, NVR and Lennar still have nine days and five days to cover held short, respectively. And, over the past month, shorts have covered 1.3 million shares in Toll Brothers. As the stocks have marched higher, shorts have been forced to cover positions - creating additional demand.

Earnings growth exceeds the market.

If the turn is indeed behind us, investors should pay close attention. The earnings power for these companies is impressive and excess costs have been wrung from their organizations. At NVR, analysts predict 33% growth in earnings per share next year. Toll's earnings are estimated increasing 109% and Lennar is anticipated seeing earnings expand by 64%. And if earnings aren't compelling enough, investors should recognize one all important fact: No one owns these stocks.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LEN, TOL, TREX, LL over the next 72 hours.