Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Don't Chase the Homebuilders

|Includes:DHI, PHM, SPDR Homebuilders ETF (XHB)

Recent strength in homebuilding stocks may set up good trading opportunities, but as long as the overall trend remains down, long-term investors should stay away.

The latest Case-Schiller Housing Price Index caught many by surprise when it reported an unexpected rise of 1.1% for June. The year-over-year results showed that the index has declined by 4.6%.

The surprise increase boosted the homebuilding stocks, as many were already trading well above their recent lows.

The Dow Jones Home Construction Index completed a major head-and-shoulders top in May 2006. It peaked in 2005 at 1100 and closed Tuesday at 208. It is down 81% from the 2005 highs.

Though the SPDR S&P Homebuilders ETF (XHB) and the key homebuilding stocks have provided some good trading opportunities in the past, there are no signs yet of a major bottom.

Click to Enlarge

Chart Analysis: The SPDR S&P Homebuilders ETF (XHB) has bounced nicely from its recent low at $13.05 and is already close to the 38.2% retracement resistance at $15.44.

  • The 50% retracement resistance from the April 29 high is at $16.10
  • There is significant chart resistance in the $17 area with the downtrend, line a, at $18
  • The relative performance, or RS analysis, broke support (line b) in July when XHB was in the $17.50 area. It has turned up but is still in a longer-term downtrend
  • The on-balance volume (OBV) moved above its weighted moving average (WMA) last week, while the weekly OBV (not shown) is still well below its declining weighted moving average
  • There is initial support for XHB in the $14.50-$14 range

D.R. Horton (DHI) is a $3.3 billion company that currently yields 1.5% and has a book value of $8.20. Its recent low was $8.82 and the stock gained 2.1% on Tuesday.

  • DHI has risen 17% from its lows and has just reached first chart resistance in the $10.50 area, line d
  • The 38.2% retracement resistance from the April 2010 high ($14.42) is at $11.40 with the downtrend, line c, at $11.80
  • The RS line broke to new lows in August and is below its short-term downtrend, line e
  • Volume has picked up on the rally, but is still below the levels seen on the early-August decline. The daily OBV is above its weighted moving average but shows no signs of an important low

Click to Enlarge

PulteGroup (PHM) was one of the star performers on Tuesday, as it was up 6.1% and is now up over 35% from the August 23 lows at $3.40. This rally should first be viewed from the long-term charts.

  • The long-term monthly chart goes back to 1999 and clearly shows the break to new lows in August with next major support, line b, in the $2.50 area
  • The support at $7.25, line a, was first broken in November 2010
  • The RS analysis moved above its weighted moving average in July 2000 and stayed above it throughout the bull market
  • The RS line finally dropped below its weighted moving average at the end of February 2006 when PHM closed at $38.40. The uptrend, line c, was broken a few months later
  • The monthly RS analysis is still negative as it is below its declining WMA

The daily chart for PHM shows the recent sharp rally with next resistance in the $5-$5.20 area. The minor 50% Fibonacci retracement resistance, as calculated from the early-2011 highs, is at $6.05.

  • There is strong chart resistance in the $6.50-$6.80 area, while the major 38.2% resistance, as calculated from the April 2010 high, is at $7.45
  • The daily RS has turned up, but so far has not been that impressive. It broke support, line f, in July before the 50% decline. Longer-term RS resistance stands at line e
  • Volume has been heavy over the past few days and there have been several days with over three times the average volume

What It Means: The recent strength in the homebuilders has been impressive. Some of the beaten-down stocks like PulteGroup (PHM) could gain another 20%-30% from current levels, but there are no signs yet of a major low.

For traders, a setback towards the recent lows may set up a trading opportunity, but long-term investors should stay away until the weekly RS analysis suggests that the homebuilders are starting to outperform the S&P 500.

How to Profit: Since it has been over six years since the homebuilders topped out, one has to think that we are within a year or so of a major low.

For traders, a 50% pullback over the next week or so could set up a good trading opportunity, but be sure the risk is well controlled because the dominant trend for the homebuilders is still down.

Stocks: XHB, DHI, PHM