The Home Builders
By Frank Barbera CMT. February 6, 2007
“Ready for the Next Leg Down in the Great Bear”
In last week's update, we spent a great deal of time discussing the Financial Sector and what appears to be signs of trouble brewing just below the surface. Sub-prime lenders, the brokerage stocks, these are two areas that speak volumes about the recent cycle. To be sure, the growth in credit that has been accelerating at an increasingly exponential rate and has been THE key driver in creating the perceived wall of endless liquidity responsible in small part for underpinning the rapid ascent in global financial markets. Yet, there are other places to look for clues.
In today’s report, we turn our attention to the recent rally in Home Building stocks to see what messages they could be sending. Of course, few sectors had a better run in recent years than the high flying homebuilders where, despite a recent rally, the fundamental news still sounds bleak. Just this week, the largest US homebuilder, DR Horton (DHI) said that net sales order in January continued to fall compared to a year ago, and that the cancellation rate, at 33%, was about the same as the prior horrific December quarter. As it stands right now, sales cancellations and inventories of unsold new homes are at record levels while at the same time, there is building evidence of spreading price declines. Back in December, the national Median Home Price was reported at $235,000 for a single family home, down 8.56% from its peak in February 2006 at $250,800. In addition, there is little substantive evidence to report at this point in time that would argue any kind of compelling case for a potential low in Housing. Historically, the housing market has been very sector cyclical, often recording important bottoms on a number of indicators at roughly the same levels. For example, Building Permits, New Housing Starts, the Ratio of Residential Fixed Investment to GDP, all of these have bottomed in the same zone during each of the last 6 or 7 recessions. Are any of them at those levels now? Absolutely not. Another good measure, an inventory gauge called “The Ratio of Houses For Sale to Houses Sold,” is spiking up sharply, indicating a housing recession underway.
Yet at a reading of 7.04% on the 6 month moving average, the gauge is still a good distance away from its former bottoming zone with readings between 8.00% and 9.00%, the kind of readings that might begin to suggest an approaching low in housing. In the preceding chart, we see the major spikes above 8.00% to 9.00% topped out at readings of 10.90 (February 1974), 11.29% (February 1975), 9.59% (April 1980), 10.02% (January 1982) and 9.49% (February 1991). That list represents a virtual “who’s-who” of housing recession bottoms at 7.01% in December; we could still have a long — painful — path ahead.
What’s more, the primary trend charts for the Housing sector do not look promising. Let’s look at perennial high flier, NVR Corp (NVR) whose business is centered around two divisions, one in homebuilding, the other in mortgage banking. As is plainly evident in the chart below, between December of 2004 and May 2006 the stock constructed a massive Head and Shoulder Reversal Top with a neckline at the $715 level. For those unfamiliar with these kinds of patterns, by far and away the majority, feature the distinctive “neckline” overshoot coming down on the right side of the head. This is a classic portrait of a major reversal top, and following the completion of the pattern, prices broke down violently. Since then, prices have been in recovery mode, snapping back up to the zone of the former neckline, a major resistance area.
So what odds would you place on NVR topping once again near current levels? Actually, if we look at the 9 week RSI, an overbought — oversold indicator, the odds are quite high. For the RSI, the “normal” parameters for overbought and oversold are +70 and +30. Yet those figures do not tell the entire tale. Typically, when a sector is in a bull market, especially a very powerful bull market, the 9 week RSI will oscillate in a higher range, between +80 and +40, in what is known as the “80-40 Rule for Bull Markets.” In bear markets, the scale tends to shift downward, with overbought at +60 and oversold at +20, in the “60/20 Rule for Bear Markets.” OK, we can hear the chorus of readers' voices, calling “Comm’on Barbera, where’s the proof, what is this 80/40 Rule?" Well, the next time you sit down in front of a chart program, start hunting around for some powerful trends and you will see the “scale shift” phenomenon at work for yourself. Look at the Tech Stocks on the weekly chart in the late 1990’s; you will see nothing but “80-40,” back and forth on the 9 week RSI. Then, when they broke down in 2000-2002, it had been 60/20 during the bear market and back to a normal 70-30 range over the last three years. Note the chart of glamour Tech leader Cisco Systems below:
OK, how about bear markets? We could go on all day, but the next chart shows the CRB in the heart of a serious bear market way back in 1997-1998. As the CRB was topping in 1997, the traditional 70-30 range applied. As prices rolled over and started locking on to a new, powerful downtrend, it was all “20-60” the whole way down. Usually, the real kick start decline in a bear market will pound the daily and weekly RSI’s down to the 20’s, with the daily RSI staying compressed until the weekly RSI is down into the 20’s. This is why, at the beginning of a bear market, prices get oversold early and STAY oversold and why it is suicide to try and pick a bottom too soon.
One more example from the recent past and then we will get on our original theme. Note below, the Oil Service stocks, in this case, Global Santa Fe (GSF) in the most recent bull move, has been all “80/40” on the weekly chart. Think I just hand picked GSF? No way; look at SLB, DO, RIG, TDW, almost any name in the entire Energy sector over the last few years, “80-40” all the way.
So with all of the above in mind, we now return to our weekly chart of NVR. Notice that when we plot the stock price on a long term weekly, logarithmic scale, all of a sudden the massive top which I showed up close and personal earlier, is less prominent and less obvious. It will still pack just as much of a wallop, rest assured. What we see on the weekly chart is the classic 80-40 Rule in effect during the long bull market advance, and with the breakdown from the H&S Top in mid-2006, the beginning of a transition phase into a bear market type condition. History tells us we should be thinking “60-20” all the way at this juncture. So where is the RSI or NVR? It is actually all the way back up to +74 on the weekly RSI, what for a bear market, would be an extremely overbought and therefore very dangerous reading.
Let's look at some of the other big players in the Homebuilding Group. In the next chart, we see the Weekly chart of Beazer Homes (BZH) which recently announced revenues down 27% yr/yr., closings down 31% in the last quarter, while new orders were down 54% yr/yr. Earnings just swung from a profit to a loss of $59 million dollars. What is the 9 week RSI saying about Beazer? Easy, we note that when the stock was in a normal range between 1995 and 1999, the traditional 70-30 scale worked well. Then, as the housing bull market turned on the juice between 2000 and 2006, BZH was a group leader and we saw the RSI scale shift higher into 80-40 mode. Since then, we see the beginning of the bust, and once again a transition phase in RSI with the low in BZH coming last July at +14.38 on the RSI and the recent weekly price high in December 29th, 2006 at an RSI of +64.84 — classic bear market “20/60” Rule in effect. The same type of phenomenon is evident in Hovnanian (HOV), DR Horton (DHI), Ryland (RYH), Toll Brothers (TOL) where all of the issues plunged to below +20 on the weekly RSI in the fall of last year and have now worked their way back to fully overbought readings in the +60 to +70 zone. In my view, with long term moving averages now turned down, the rest of the rally in these stocks is an upward counter-trend bounce that is now fully overbought and ripe for a renewed decline.
Above: Beazer Homes with RSI scale shift Below: Hovnanian with RSI scale shift
Note the terribly weak nature of the recent counter-trend rally in these stocks; it screams out that there is more to come on the downside, something we should know very shortly considering the degree of the current overbought values.
In addition to the Weekly RSI, there are other technical gauges presently hinting that the medium term rally in Homebuilding shares could be nearing its end. In the next chart, we look at the ARMS Index for a group of 20 Homebuilding stocks wherein high readings above 1.50 (the upper horizontal line) indicate “fear” and the prospect of a market low, while “low” readings below .70 indicate “optimism” and the prospect of at least a short term peak. In the case of the ARMS Index for Homebuilding shares, the indicator has once again declined below .68 to a reading of over just the last two days. Will this mark another important high? Clearly it is too soon to tell, but if prices reverse to the downside on the order of 2% or more over the next few days, the odds will be high that an important “failing” peak will have been set in place.
Above: the Homebuilding stocks with the Daily ARMS Index, back to fully overbought territory.
Another piece of technical evidence which is quite striking is the miserable “relative performance” the group as a whole has shown in the face of a very robust stock market. In the next chart, I show my own Index of Homebuilding stocks in the top clip, and in the bottom clip, the Relative Strength Ratio of Homebuilders to the S&P. Time and time again, we have heard one Wall Street stooge after another come out and tell us that the “housing market has already hit bottom,” that an improvement is “right around the corner” etc… OK, if that is true, how come Wall Street fund managers haven’t piled back into these depressed stocks? How come the relative strength ratio line for homebuilders versus the S&P is dead flat during one of the most powerful stock market rallies in recent years? Why? — Aha!!! — The only answer that comes to mind on this score is that Wall Street doesn’t even believe its own rhetoric where homebuilders are concerned, fair warning to the rest of us to stay away, -- far, far, far away.
Above: The GST Homebuilding Index and Below (lower clip): the Relative Strength Ratio of Homebuilders to S&P 500. Note that during the strong stock market rally of the last few months, homebuilders have lagged behind with a flat ratio line, a sign that Wall Street doesn’t buy into the “housing has bottomed” view.
In looking at today’s closing numbers, the Dow edged higher by 4.57 to close at 12,666.31, the S&P was up 1.01 to finish at 1448.00, while the NASDAQ ended higher, up +.89 to close at 2,471.49. Crude Oil closed higher by +.10 to finish at $58.88, while gold was up +2.60 to end at $658.70. The 10-year Bond Yield ended at 4.77%.
© 2007 Frank Barbera