The homebuilders' group is currently at a critical juncture, and is an important sector to watch for signs of a real bottom in the markets. The stock market moves in cycles that are correlated, yet not in sync with cycles in the economy. Typically, the stock market will peak ahead of the economy and bottom before a recession has ended. The reason the stock market tends to lead, is that investors will always attempt to position themselves based on what they perceive will happen in the subsequent months.

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The homebuilders are usually one of the first groups to lead in a new bull market, as investors attempt to get ahead of an economic recovery, causing an increase in demand for new construction. Of course, we are experiencing a unique bear market, which is intimately tied to real estate, and there is no guarantee this market will follow a similar pattern. The fundamental picture for housing stocks and real estate in general remains bleak at best. However, in looking at the stocks for the homebuilders, it's interesting to note that they have been recovering some of their recent losses, and while the true reason remains unknown, it bears watching.

The SPDR S&P Homebuilders ETF (NYSE:XHB) attempts to replicate the S&P Homebuilders Select Industry Index. In looking at a chart of the last four years' worth of trading, it is clear that XHB has been in a persistent downtrend. XHB has been setting lower highs and lower lows while dropping from the $40s to under $10 in early 2009. However, an interesting thing happened in August. XHB was able to set a higher high as it cleared a peak set in May. It has been consolidating since then, while holding over the breakout area. Currently, XHB is inching toward a test of a long-term declining trendline, which has rejected earlier attempts at a breakout. It will be interesting to see how this ETF handles the test. (For more, check out Introduction To Exchange-Traded Funds.)

Source: StockCharts.com

In drilling down to some of the individual names, many are also at critical junctures. Toll Brothers (NYSE:TOL), for instance, is in the process of testing an important level. TOL cleared a wide base in August, but quickly fell into a consolidation that has been taking place just above the breakout area. TOL is currently near the lower end of this range and would need to turn higher from here soon, or risk a failed breakout attempt. (For related reading, check out Trading Failed Breaks.)

Source: StockCharts.com

Hovnanian Enterprises (NYSE:HOV) is yet another example of a home builder testing an important level. Much like TOL, HOV cleared a base in August and has been consolidating the breakout. HOV has respected the breakout level and is attempting to bounce back to test the upper range of the consolidation. A move above $5.75 would signal a probable resumption of the breakout.

Source: StockCharts.com

Lennar Corporation, (NYSE:LEN), on the other hand, clearly broke out from a base, and has been on a strong trend higher. LEN has been respecting the 20-day moving average on pullbacks, and appears to have formed an important bottom in the $8-$10 area. While LEN could easily consolidate some of its recent gains, it's still looking strong, and is a likely candidate to find support on pullbacks. The September low is a level to watch as a possible signal of a deeper correction if breached.

Source: StockCharts.com

Beazer Homes USA (NYSE:BZH) is also in the process of a strong breakout. BZH was hit pretty hard during last year's run on the homebuilders, and was close to worthless for a while, trading down to 24 cents amid speculation of a bankruptcy. BZH was able to make adjustments, and has been one of the stronger home builders from a stock price performance perspective over the past year. BZH is currently a little extended, but appears to have strong support near the $4 area.

Source: StockCharts.com

Bottom Line
The homebuilders remain an interesting group to watch, because much like the financials, it is unknown how much of the current rally is due to overpricing failure on the way down, or due to expected improvement in the fundamentals in the future. As traders, the reason is not as important as watching the price action. The charts have been showing an improvement in these stocks, and with XHB beginning to set higher highs and lows, it's possible that a bottom has been put in. It will be interesting to see if XHB can survive the upcoming test of resistance, and hold above the lows it set in July. If it does, it would be a very strong signal for the group as a whole.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!


At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

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