Time to dump homebuilder stocks

Shares are in decline and look to have plenty more room to fall.

By MSN Money Partner Mar 31, 2014 4:42PM
Home under construction © CorbisBy Michael Kahn, MarketWatch

After a nice six-month run, the housing recovery story has soured, at least according to the stock market. Shares of homebuilding companies are in decline and look to have plenty more room to fall.

That deals a big blow to those looking for stronger housing propping up the fragile economic recovery. And even though there was good news on the earnings front from the likes of KB Home (KBH) and Lennar (LEN) in the middle of last month, the overall industry news is questionable. For example, existing-home sales in February were the slowest since July 2012. Builder confidence plunged that month, too.

The charts tell the story. Last month, the iShares U.S. Home Construction ETF (ITB) rallied up to levels not seen since May 2013 and closed above that resistance level. But within days, the sellers took over, prices fell and the technical breakout failed. 

Chart watchers will note that failed bullish signals often become bearish signals, and for homebuilders, it was certainly true. Prices have been in decline even since.

There was a brief awakening on March 19 as KB Home released its better-than-expected earnings. The stock and its peers jumped nicely on the news, but for the latter, the strength faded and the gains evaporated into the close.

The next day, Lennar also beat expectations, and its stock jumped. This time, however, the rest of the sector did not respond, and it all headed south. Poor action on good fundamental news is technically bearish.

But it got worse. The homebuilder ETF sliced through its 50-day moving average to the downside and broke rising trendlines in both absolute and relative performance charts. In other words, the trend was confirmed to be to the downside.

To be sure, there is chart support at the 23-24 level, using round numbers, and a small violation would not change that. But a move under 23 would also break a second trendline and put the ETF below its 200-day moving average. That could trigger a stampede to the exits and professional investors change gears. A drop to the 20-21 area would not be a surprise, and while the change seems small, in percentage terms, it would represent a 16 percent drop from late March levels. That's ugly in anyone’s book.

One member of the group that is poised to lead to the downside is Pulte Group (PHM). History tells us that stocks that lag on the way up tend to lead on the way down. Why? Because as "less loved" members of the group, they are the easiest psychologically to sell.

Pulte was not able to rally back to its May 2013 highs, and it broke its respective trendline several weeks before the sector ETF did. And the short-lived sector-earnings rally seen March 19 served to test that breakdown. A test is a rally back to a breakdown level giving bears one more chance to sell. They did. And in spades. There is 20 percent or more downside to Pulte's summertime lows.

There is one caveat; Pulte offers a crazy low trailing price/earnings ratio of 2.8. I am not an expert in this area, but its peers average ratios in the 20s, so something else must be going on here. As a technical analyst, such a low ratio suggests to me that the market sees real problems ahead and that the "E" in the P/E ratio is going to tumble. In other words, based on the valuation metric, it is too good to be true.

Another factor to watch for the sector is interest rates. The benchmark 10-year Treasury rate is threatening a technical breakdown, and that could translate into lower mortgage rates. However, since Fed Chief Janet Yellen made her comments March 19, that relationship has been strained. Lower rates may not help housing at all.

Investors should be careful in the homebuilding sector. The charts paint a weak picture and smart money seems to be fleeing.

Michael Kahn writes the Getting Technical column for Barron’s Online , which analyzes sectors and markets. 

More from MarketWatch

Mar 31, 2014 5:07PM
Anyone priced building materials lately?  They are skyrocketing...
Apr 1, 2014 10:56AM

from what I see in my town area, there are seriously large apartment complexes going up (some 500+ units near a mall and freeway), a giant retirement center, 3 large townhome complexes, all under construction.  the townhomes start at $450,000.  the rentals are starting at near $2000 per month. 


there is demand in some parts of the country. 

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