Homebuilders: The Real Deal or Just Another Bear Market Rally?

The most recent rally in homebuilders has been impressive. Since putting in a bottom January 18, the Philadelphia Housing Index [$HGX] had gained nearly 30% by February 1. That is an impressive two-week gain no matter which way you slice it.

But this is not first time homebuilders have posted an impressive rally since the new housing bear market began in early 2006. Between July 2006 and April 2007, the HGX gained 30% before the bear took over again. The reason? Underlying fundamentals never supported it.

click both charts to enlarge

As we see from the chart above, while builders were rocking last time, the fundamentals like earnings growth [GRT], revenues and other internals continued to weaken. I have found price to be the leading indicator in any market reversal but if the fundamentals don't follow in the next 2-4 months, its time to head for the exits. And so far in this latest rally, the fundamentals have continued to look terrible.

In looking at the bigger picture, the broader market fundamentals don't look any better. Median prices for both new and existing homes continue to fall and annual sales rates continue to weaken (despite claims to the contrary from National Association of Realtors' cheerleader Lawrence Yun). For an accurate take, just take a look at the Case-Shiller home price index which has registered 11 consecutive monthly declines. More importantly the rate of change of those declines is still accelerating.

Until underlying fundamentals start to recover, its a trader's market and that means shorting the rallies and only buying the dips if you are aggressive and have tight stops.

Disclosure: none