Trader’s Narrative

If you think the financial sector has been roughed up, check out a long term chart for the homebuilders. They’ve gotten crushed.

Although it is always most difficult, it is rewarding to step in and buy when no one else is. Right now sentiment and the technicals have reached a crescendo of pessimism that usually signals an inflection point.

Take a look at the chart to the left. It is a survey from the National Association of Home Builders (NAHB) showing that only 28% of them see the housing market as “good or fair”. To put it in perspective, this is the lowest reading in 16 years. Very gloomy. Very doomy. Wouldn’t you say?

And there’s more. An economist with Moody’s economy.com wrote recently, “The bottom of the housing market appears nowhere in sight”. Ouch.

If we look at the sector using the SPDR S&P Homebuilders (XHB) ETF, we get an idea of the carnage in this sector. Right now, there are zero stocks in this sector above their 10 day moving average. A paltry 5% above their 50 day moving average and only 24% above their long term, 200 day moving average. That is extremely oversold on all time frames.

Now, I know things are really ugly out there. Not only on the charts, but also with fundamental factors like foreclosures, ebbing liquidity, stricter lending practices, unsold home inventories, etc. But technical analysis attempts to look over what is happening right now, to what is coming.

So I’m not trying to be a pollyanna when I say that this sector merits attention. I acknowledge all of this and because of the confluence of it and the technical and sentiment picture, I think there’s an opportunity.

Here’s another data point to throw into the pot. The short interest ratio of this sector is 5.3 or 15.4 million shares. That’s come down from last month but still provides a contrarian support to my thesis since shorts provide a bid below price and above price, their stop losses creates momentum to the upside. Of course, this has to be taken with a salt mine since a lot of traders use the ETF to hedge otherwise long positions in the sector (long home building stock & short sector or other exotic combos).

In any case, the price action of the sector ETF (XHB) as well as the individual components is key. Yesterday both showed a decidedly bullish move. Many an engulfing bullish candle was formed as buyers finally came in and pushed homebuilders up for a change. The fact that there was volume behind the price action gives even more impetus for a bullish stance.

Take a look at Beazer Homes (BZH). It is right at pivot support around $28:

I’d be looking for similar bullish setups in the homebuilding stocks. Another example is WCI Communities (WCI) which formed a hammer on high volume after a protracted and sharp decline. And finally, take a look at Centex (CTX) as it found support at $40 - its 2004 summer low.