Homebuilders Construct Technical Breakout

Homebuilding stocks endured a tough 2018 due to weak buyer demand caused by a combination of affordability issues and higher mortgage interest rates for much of the year. The sector's barometer exchange-traded fund, the iShares U.S. Home Construction ETF (ITB), closed out the year in the basement, down 31%.

However, sentiment may be about to change. Recession fears over the fourth quarter have seen an influx of money flow into treasuries that have increased their price and lowered yields, which is helping put downward pressure on mortgage rates. Moreover, although Federal Reserve Chair Jerome Powell indicated last month that the Federal Reserve intends to raise interest rates twice in 2019 and put its balance sheet unwind on autopilot, he further clarified Friday that the central bank was aware of risks to the U.S. economy and would exercise patience and flexibility in regard to policy decisions.

According to analysts, the homebuilding sector should also benefit from increasing millennial household formation and increased spending on remodeling and renovations. "There are over 126 million U.S. households that are ripe for home improvement. The consumers are enjoying job growth and higher income; they're going to spend money on the existing houses," Thomas J. Thornton, head of U.S. equity product management at Jefferies Financial Group, told clients in a note, per CNBC.

From a technical standpoint, several leading homebuilding stocks have broken above significant downtrend lines that offer breakout traders a short-term swing trading opportunity. Let's look at three possible trades.

D.R. Horton, Inc. (DHI)

Headquartered in Arlington, Texas, D.R. Horton, Inc. (DHI) primarily builds single-family detached homes such as townhouses, duplexes and triplexes across 27 states. The company, founded in 1978, also offers mortgage financing and title agency services. Trading at $36.75, with a market capitalization of $13.73 billion and paying a 1.63% dividend yield, the stock is down nearly 9% over the past three months as of Jan. 7, 2019, but has returned 6.03% over the first three trading sessions of the new year. Analysts project D.R. Horton's 2019 earnings to grow 4.6%.

D.R. Horton's share price trended steadily lower between mid-August and late December. Buyers have since stepped in to push the stock above its 50-day simple moving average (SMA) and a downtrend line that connects multiple swing highs. Traders who buy at the current price should set a profit target near $40, where the price finds resistance from a horizontal line and the 200-day SMA. A stop could sit just below the $35.50 breakout level to close losing trades if the price fails to follow through to the upside.

Lennar Corporation (LEN)

Lennar Corporation (LEN), founded in 1954, constructs single-family attached and detached homes in communities aimed toward first-time homebuyers, move-up homebuyers, active adult homebuyers and luxury homebuyers. The Miami-based company also operates a financial services segment that provides mortgage financing and related services. Lennar, with a market cap of $13.61 billion, is well positioned to become the largest homebuilder in the United States after merging with CalAtlantic in 2018. As of Jan. 7, 2019, Lennar stock has fallen 7.70% over the past three months. However, it has jumped 5.26% year to date (YTD). The company offers investors a 0.39% dividend.

Lennar's share price fell roughly 25% between mid-September and late October before trading sideways and making a lower low near the end of 2018. The relative strength index (RSI) formed a shallower low at the same time, which is referred to as bullish divergence and indicates a possible trend reversal. The stock broke above a four-month downtrend line Friday that may trigger further buying. Those who enter on the long side should aim to ride a move up to the $50 level – an area where the price encounters significant resistance from horizontal line price action and the 200-day SMA. Consider placing stop-loss orders under the 2019 low at $38.28.

PulteGroup, Inc. (PHM)

With a market cap of $7.64 billion, PulteGroup, Inc. (PHM) predominantly builds single-family detached homes that target entry-level, move-up and active buyers. The company, which operates in 25 states and pays a 1.62% dividend yield, also arranges financing options, such as originating mortgage loans and providing title insurance policies. In October, the homebuilder raised its fourth quarter average sales price forecast from $420,000 to $430,000. Although PulteGroup stock has returned a disappointing -14.80% over the past three months, its share price has risen 4.66% YTD as of Jan. 7, 2019.

PulteGroup shares fell sharply in September and most of October before staging an impressive 28% rally midway through the fourth quarter. In Friday trading, the price broke above a month-long consolidation area as well as a downtrend line dating back to June. Traders who open a long position should place a stop below the 50-day SMA and book profits at $31, where the stock could run into resistance from the May and July swing highs.