Homebuilding Stocks

Along with everybody else, we’ve been watching the housing sector for many months here at The Kelly Letter. From the abundance of homebuilders beaten down, we chose one in particular that we’d like to own and have been watching for a bottom as it fell from $35 to $15.

Last weekend, I told subscribers that the letter would continue waiting as it looked like there’s still plenty of bad news left in the housing sector.

Yesterday, Citigroup analyst Stephen Kim threw his hat in the ring, and it was painted bright bullish green. From his research note:

The woes in the U.S. housing sector have been extensively documented, and we do not pretend that any near-term relief in industry fundamentals is in sight. However, it bears repeating that the home-building stocks have an established history of rallying well before industry fears have finished transitioning into fact.

We are not trying to suggest that trends in the home-building sector are about to get much better. . . they have never been worse. And in this sector, with its long history of feverish booms and catastrophic busts, it is precisely when things have gotten this bad that the stocks start looking good.

He noted that the stocks are trading at the lowest price-to-book values they’ve seen in 30 years, and predicted a winter rally.

Naturally, shares across the sector leapt at the news. Beazer gained 12%, Meritage gained 10%, Hovnanian and Ryland each gained 8%, D.R. Horton gained 7%, Lennar gained 6%, and Pulte gained 5%.

There are a few things to bear in mind.

First, even after yesterday’s spike upward, the stocks are still 50% to 80% off their highs.

Second, most of yesterday’s spike was most likely caused by short covering at the first sign of life in the sector. All were heavily shorted.

Third, according to last week’s S&P;/Case-Shiller home-price index, prices in 20 of the biggest cities fell by a tiny 3.9% in the year to July. That’s a far cry from the 20% to 30% corrections that the futures market predicts. Moreover, if that’s as bad as this supposed housing crisis gets, why in the world are we using the word “crisis” at all?

With that much more downside available, and with as much fear around October as we’ve seen, I think it wise to wait longer before bottom fishing the housing sector.

Mind you, I agree with Mr. Kim about the good prospects for housing stocks, and my medium-term general market forecast is bullish. I’m simply holding out for as cheap a price as possible and don’t think we’ve seen it yet.

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