Home Builders Show Signs of Life

10/15/2008 9:50 am EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer's Investment Research says sentiment about housing-related stocks remains terrible despite the group's recent big move.

In a reaction that could become common on Wall Street, Sam Stovall, chief investment strategist for Standard & Poor's Equity Research Services, said in Business Week that he "nearly fell off my [his] chair" when the Standard & Poor's 1500 Homebuilding subindustry index appeared on his weekly high-momentum list.

According to Stovall, "the homebuilding group was only one of 13 subindustries to post 12-month price gains." He goes on to note that the index "broke above its moving 39-week average in March 2008 and successfully retested the average in July." Stovall, however, remains cautious, as the index has soared "maybe too swiftly for my liking."

The investment strategist goes on to note that analysts at S&P Equity Research are pretty lukewarm toward the homebuilders sector. "S&P has a neutral fundamental outlook for the homebuilding group." In fact, of the 12 stocks in the index that S&P covers, only D.R. Horton (NYSE: DHI), MDC Holdings (NYSE: MDC), and Toll Brothers (NYSE: TOL) receive four stars, or Buy recommendations.

In conclusion, Stovall reports that while S&P "expects that the present cyclical downturn should be more manageable," the outlook "remains very cautious, especially regarding smaller, less geographically diverse builders."

Honestly, skepticism toward the homebuilding sector is understandable. The group is still receiving blame for the credit crisis and the current downturn in the global economy. However, as we noted recently, the situation is beginning to look quite favorable for housing stocks. Specifically, the Philadelphia Stock Exchange's Housing Sector index (HGX) rallied more than 38% since its mid-July lows.

On the sentiment front, despite this strong technical performance, investors remain heavily bearish on housing stocks. Specifically, Toll Brothers' put/call open interest ratio (SOIR) of 1.29 rests in the 89th percentile of its annual range, while Ryland Group's (NYSE: RYL) SOIR rests just two percentage points shy of an annual high.

Additionally, Wall Street is betting against the group, as four of the eight analysts following RYL rate the shares a Hold or worse, while five of the eight brokerage firm's covering TOL have issued Hold or worse ratings. An unwinding of this negativity could help pressure the housing sector steadily higher.

(TOL's stock closed around $20 Tuesday, RYL closed below $19, DHI closed above $8, and MDC closed above $32. All are well off recent highs-Editor.)
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