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Homebuilder and GSE Stocks - Technical Evidence Suggests Top Is In

The homebuilders have had a bull market of historic proportion. From early 2000 at the time of the bursting of the technology and telecom bubble, homebuilders as measured by the Dow Jones Home Construction Index, have increased in stock price by over 300%. Before that time the index was in a bear market. If you are a bull in this sector, you may be asking yourself, “How could the stock market have mis-priced these stocks before the homebuilder bull market?” Those such as myself who are bearish on the sector would have to ask, “When will the mania end?” Based on technical evidence, those with long positions and sitting on long-term capital gains may want to consider hitting the “sell” button. In tonight’s article I will present evidence that indicates that the bull market for both homebuilders and the related Government Sponsored Enterprises (GSE’s) may end soon.

Homebuilder Stocks – The Long View

Below is a 5-year weekly chart of the DJ Home Construction plotted on a percentage gain basis. The upper and lower up trend lines are indicated in white on the chart. After a bull run that began in mid-2000, the upper channel line was broken more than 3 years later, in the 4th quarter of 2003. You would be normal to wonder as I do, what excellent new fundamentals gripped the homebuilders that warrant such recent emotional buying not seen in 3 years and a 250% price increase. A logical person would question whether the people most knowledgeable in the industry, insiders, would have bought. Golly, maybe insider buying was propelling the stocks higher in the 4th quarter and after the New Year.

Here is a table of company insider buying versus selling in most of the major homebuilder stocks over the most recent 6 months.

It appears as though there may be more insiders selling than buying. There were 3.16 million shares sold, and only 0.034 million bought. (I suppose the company insiders don’t watch all of the bullish information that is presented on financial cable TV channels.) This is a ratio of 92 to 1, more than two times the insider-selling ratio of the general stock market, which is at about 40 to 1.

The following chart is a one-year daily chart of the Dow Home Construction Index plotted along side of the Dow Home Furnishings and Appliance Index. These two indices are related in a similar way as the Dow Jones Industrial Average is related to the Transportation Average (see). In October 2003, it appeared that the home furnishings index was about ready to roll over. It appeared that the non-confirmation of this index was spelling trouble for the then-surging homebuilders, as I pointed out in this FSO space. As it turned out, this was too early (see chart note: “early”). A whipsaw ensued. The surging homebuilders pulled upward the then-faltering home furnishers. However, the Dow theory-like concept of confirmation is still worth revisiting and considering for the homebuilders and furnishers. As shown on the chart below, the furnishers appeared to have topped, having made a head-and-shoulders top formation. However, the completion of the topping pattern has not been confirmed. The bearish plunging neckline has not yet been broken. In the meantime, the homebuilders index sits right at its lower (up) trend line. If that trend line is broken decisively, it will spell additional technical breakdown for the homebuilders. The trendline appears to have been broken; however, as I draft this on Wednesday evening, a decisive trendline break has not yet occurred.

A Look Back to the Recent Past

The following charts are homebuilder stocks performance from the approximate 6-month period ranging from April to October of 2003. At that time, practically all of the homebuilders were showing very healthy technical charts. The general pattern for all of them was an up trend, followed by a regular cup-like correction, and then an upside breakout to new high ground. The homebuilding sector was a “picture of health” at that time.

Picture of Health (April to October 15, 2003)

Last 6 Months - Emotionally Charged, but Not a Picture of Health

If we examine the most recent 6-month timeframe of representative members of the homebuilding sector, we find that this is no longer a picture of health. Of the six stock charts illustrated, three of them show a clear “double-top” formation – Beazer, Hovnanian, and Ryland Homes. (Hovnanian is tracing a longer-term descending triangle, described below.) NVR Homes is tracing out a clear descending triangle, practically always a bearish technical pattern if broken. It has also shown technical weakness just after the New Year. The two strongest of the illustrated homebuilder stocks – Centex and Toll Brothers are nearing important support/resistance lines, at 50 and 42.5, respectively. Breaking into these support areas in a decisive way will spell more trouble for the sector. Note how all of the homebuilder stocks have recently violated their respective 50-day moving averages for the third time. This is not a good sign.

I have featured two of the weakest of the homebuilder charts – Hovnanian and Ryland Homes - to detail technical weakness in the homebuilding sector.

Hovnanian Enterprises – Losing Momentum

The chart below is an 18-month daily chart of Hovnanian Enterprises (HOV). The key former resistance, and now support level is 35. Its former up trend was broken, and the stock tried to make top after having broken the up trend. It failed, and now the stock is trading on diminishing volume. It split 2 for 1 in March. There are several momentum indicators that are showing weakness “below the surface”. Note the divergence between on money flow (a gauge of up versus down volume) that occurred between the intermediate top in September, and the ultimate top in December. The chart is bearish.

Ryland Homes – Bearish Three Strikes, Cockroach, Strike Four, Fall

The 6-month chart of the Ryland Group (RYL) is shown below. I would have to say that the chart is not showing any classical technical pattern of which I am familiar. However, analysis of the Ryland chart is similar to a commonly used definition of pornography. You can’t identify a defined bearish pattern, but you can sure tell it is there. It is clear to me that this is an emotionally charged situation and the pattern of lower lows, suggests a very bearish situation. In case this pattern begins to commonly reoccur, I will coin the phrase representing the technical pattern. I’ll call it “Three strikes, Cockroach, Strike four”. This “technical pattern” consists of three attempts at a new high, followed by a gap down below the two recent lows, followed by apparent panic buying to the previous high, followed by a fourth and final failure confirming a new intermediate or long-term downtrend.

Note also, the bearish price/volume action as indicated by the on balance (up versus down) volume and money flow. Again there was a divergence between price action (making new highs) and money flow (making lower highs).

There is a clear candlestick pattern known as a “belt hold” that represented a good bearish entry point (which I used). This is a long red (down) candle that covers the entire more recent uptrend (illustrated below).

Fanny and Freddie – Weakness Indicated

The Government Sponsored Enterprise (GSE) stocks are showing weakness. Freddie Mac (FRE) is showing more weakness than Fannie May (FNM). For completeness, the chart of Fannie May follows. Fannie is showing distribution and a potential head and shoulders pattern.

Following is the long-term monthly chart of Freddie Mac.

On the basis of long-term momentum indicators, Freddie Mac is showing technical weakness. The indices above the chart illustrate volume-related momentum indicators. As you can see, there is a clear long-term loss of volume momentum as indicated by the 12-month money flow, and the clear long-term distribution. Similarly the 14-month RSI shows a consistent trend of lower highs and lower lows, after having topped back in 1999. While long-term momentum indicators seem to show that the secular trend for FRE has turned from up to down, shorter term chart analyses are needed to provide practical trading entrance and exit points. Following is a shorter-term chart:

Note the sloppy downward sloping channel line. The break of the upper channel line may be an exhaustion move. When (if) the price breaks back into the channel, the stock will be in a weak position, and the exhaustion move will be confirmed. Here is a shorter-term chart of FRE.

A decisive break into the channel would occur at about 54. Note the weakness shown by the relative price, 14-day RSI divergence, and the 12-day Rate of Change. Note the June 2003 Cockroach. Not a bullish sign.

Insider information: Freddie Mac is 1% owned by insiders. Insider purchases and sales are not listed. Yahoo! Finance indicates that Fannie May insiders sold 207,000 shares over the last 6 months versus insider purchases at (“N/A”).

Last Word - What Could Go Wrong

My analysis clearly shows technical weakness in the homebuilders and GSE’s. So is there a ton of money to be made on the short side? As anything in technical analysis, no opportunity has a 100% probability. The game is similar to counting cards at the blackjack table. You only can put the odds in your favor. You cannot be right all of the time (that is why there are stop losses). What can prove this analysis wrong? The historic bull market in homebuilders and GSE’s was supported by the Fed’s lose money policy and corresponding bull market in bonds. Similarly, the recent thrashing of the bond market on the threat of higher interest rates from the Fed is presently driving the weakness in the homebuilder stocks. So what can go wrong for homebuilder bears?

1.   Interest rates ticking up could spur one last round of panic house buying because of fear that interest rates will not continue at historic low levels. This would be enough for one last “good quarter” for the homebuilders. This may be good enough for a final climax run for the homebuilder stocks.

2.   A bond market rally (whatever the cause) and the resulting low interest rates could allow the home buying party to continue.

Just trying to be fair and balanced.

Summary and Conclusion

The homebuilders and government sponsored enterprise (GSE) stocks are showing technical weakness. It appears that the top is in.

Today’s Market

The weekly jobless number showed a large increase in jobless numbers, going against the prevailing trend of decreases in weekly jobless claims. Commodities gained some footing. Oil was up, gold up, silver up; the dollar was down; all marginally. The Dow and S&P 500 finished little changed on high volume. This was churning and not a bullish sign.

Leaders were the large pharmaceutical companies Pfizer, Johnson & Johnson and Merck. The Nasdaq logged another distribution day. With very little investment value at their current valuations, and traders only buying and selling for the rise or fall, look for holding and breaking of key even number support figures. Today, the Nasdaq barely held the 2,000 mark. It pierced it at midday.  It that falls, the next stop is likely 1,900. After topping, the Nasdaq failed to make the 2,100 mark. See the technical chart below:

The Nasdaq is showing technical weakness.

The 10-year note was down today (interest rates up) marginally. Interest rates were the highest that they have been through this year, 3-1/2 months. One can only imagine what bonds would have done if the weekly jobless number was lower.

The action in the homebuilders was pretty neutral today, and Fannie and Freddie were little changed.

I’m off to Boston for a couple of days to tour Boston University with my daughter. Have a great evening.

Have a great evening!

Martin Goldberg

Disclosure - Martin is short Ryland.

Copyright © 2004 All rights reserved. Martin F. Goldberg, MS, P.E. Market Analyst Expert Page Commentary Archive Email

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