Avoid These Homebuilders

03/03/2011 10:10 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

Despite growing optimism and speculation about a housing recovery, the technical picture for top homebuilding stocks Pulte Group and KB Home remains a house of horrors.

Investors and economists focus closely each month on the latest housing market data in hopes that they will see signs of a much-anticipated bottom. Many apparently believe that a real economic recovery must include a turnaround in the housing market.

Of course, we all hope that the housing market is close to bottoming, but the technical outlook for the homebuilders suggests that they do not yet deserve a place in your portfolio. The SPDR S&P Homebuilders ETF (XHB) is still in a shallow uptrend from the summer lows and is up a nice 26% from the close on August 31. This essentially matches the performance of the S&P 500, but it is well below the stellar performance of some other industry groups like coal and oil equipment, which are up over 50% during the same time period. The weekly technical outlook for two of the primary homebuilding stocks clearly suggests they should be avoided at this time.

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Chart Analysis: Pulte Group (PHM) has one of the weakest charts of the homebuilders, as after trading as high as $13.91 in April 2010, the stock plunged through major support, line b, last June.

  • This creates major resistance in the $8.50-$11.50 area, as many bought PHM in this range over the past two years. Those who are long are likely looking for a chance to get out of their positions somewhere close to breakeven

  • The longer-term downtrend, line a, is now in the $9 area. The 2008 highs are above $23

  • The pattern of lower highs and lower lows on the weekly chart confirms the longer-term downtrend

  • Next support is in the $6.00-$6.20 area and the break through major support has downside targets in the $4 area

  • The weekly on-balance volume (OBV) has dropped below its weighted moving average (WMA) as it failed to move substantially above its downtrend (line c) on the recent rally

The weekly chart of KB Home (KBH) shows that it was trading above $20 in early 2010 before dropping to a low of $9.43 last August. The longer-term downtrend (line a) goes back to the 2008 highs at $25.43.

  • The major support (line e) was violated last summer and was retested early in 2011. This now represents strong resistance in the $15-$16 area. A move back above this level is needed to break the pattern of lower highs and lower lows

  • Initial support in the $13 area is now being tested with stronger support in the $11.50 area. There is long-term support (line f) in the $10 area

  • Volume was weak on the recent rally as the OBV failed well below the downtrend, line g. The weekly OBV is now back below its weighted moving average, which is a sign of weakness

What It Means: Though the homebuilding ETF has matched the performance of the S&P over the past six months, PHM and KBH are clearly two of the weaker homebuilding stocks. Overall, there are no clear signs that the industry group has formed a major bottom, as it completed a long-term, head-and-shoulders top in 2006. Therefore, this industry group does not currently warrant inclusion in your portfolio.

How to Profit: For those who are long either PHM or KBH, I would either sell your longs or use very tight stops on existing positions. The daily uptrend in the homebuilders ETF XHB is now at $17.00, so a stop under this level should protect profits on existing longs. The daily OBV has turned negative, and if you are already long XHB, I would close out longs on a rally back to the $17.90-$18.30 area.

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