Not yet time for homebuilder stocks

Good news during a correction helps, but wait for the carnage to end.

By InvestorPlace May 18, 2012 10:04AM

By Ethan Roberts


This week we finally received a little good news for the housing industry. New home starts exceeded analysts' estimates, rising 2.6% and reaching an annualized 717,000 units. At the same time, permits fell some 7%. However, that decline isn't particularly worrisome because most of it was due to a 20.8% drop in multifamily permits. This shows homebuilders are beginning to see more strength in the long-suffering single-family home market.


Homebuilders are feeling more positive these days as well. The National Association of Homebuilder sentiment index rose 5 points in May, after falling 4 points in April. The National Association of Home Builders' Chairman Barry Rutenberg released a statement saying builders are reporting an increase in buyer traffic and sales. Several areas of the country -- such as the Northeast, South and Midwest -- are showing improvement.


Many factors are contributing to an upsurge in demand for new construction. Foreclosures are becoming a bit more difficult to grab as investors with cash come out of the woodwork to offer competition to owner-occupant buyers. Interest rates are simply incredible right now, with the nationwide average for a 30-year fixed-rate loan at a record low around 3.75%. Even 15-year loans are barely about 3% right now! Also, prices for new construction are still much cheaper than they were five years ago.


However, in case you hadn't noticed, the stock market is in the middle of a huge correction right now. So even though homebuilder stocks had reason to celebrate for a day when the confidence report came out on Tuesday, a wave of selling came over them and quickly knocked them back Wednesday.


Lennar (LEN), which began Wednesday's trading session by testing its recent highs around $30.12, reversed course to finish at $29.27. An intraday reversal such as this is usually a negative sign. Sure enough, on Thursday, the stock dropped all the way to $26.39 on heavy volume of 11.5 million shares.


Other notable homebuilder stocks -- such as Beazer Homes (BZH), Hovnanian Enterprises (HOV), Ryland Group (RYL) and Toll Brothers (TOL) -- were all down more than 3% Thursday. Ryland was the weakest of the group, dropping 6.94%.


As you can see from the chart of LEN, things look somewhat negative at the moment. A huge bearish "engulfing candlestick" was created from Thursday's action (yellow arrow), and several technical indicators such as RSI, MACD and stochastic are already giving off sell signals.


Perhaps the best strategy for investors at a time like this is to get out of the way and let the correction run its course. Unless we get a dead-cat bounce for a few days, it might already be too late to buy puts and too early to buy calls. But sometimes the best trade is no trade, and that's where we are right now as we await a better opportunity.


I continue to like Lennar as one of the stronger homebuilder stocks, but I would look for a pullback to the April support area around $24.50 before making a purchase.


It's also important to keep in mind that although the homebuilder sentiment index is showing improvement, the current reading still is only 29. A reading above 50 is considered bullish for the industry. Also, organizations such as the NAHB and the National Association of Realtors are always going to spin the numbers to seem better than they really are because they're in the business of selling homes.


So despite the positive signs this week, let's practice a bit of patience. Let the current market correction run its course and await a better day to invest in the home industry.


As of this writing, Ethan Roberts did not hold a position in any of the aforementioned securities.


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