In my previous article, I pointed out that overlaying charts gives traders and investors an advantage by framing price movements in an historical context. Currently, the homebuilder stock charts are showing a high correlation to the NASDAQ chart from 1995 – 2000. And if this relationship holds up, last week’s sharp correction could be the beginning of the end for the blistering rise in housing stocks.
Using traditional technical analysis, the homebuilding stocks, as represented by the Philadelphia Stock Exchange Housing Index (HGX), are undergoing a sharp, but not unexpected, correction after a strong move higher.
The index has undergone many similar corrections since it began its advance in 2000. However, overlaying a composite of the housing stocks with the NASDAQ chart from 2000 indicates that this correction could turn into something more ominous. Specifically, the homebuilder stocks seem to be tracing out a similar pattern to the NASDAQ bubble. The homebuilder stocks have now advanced the same percentage as the NASDAQ advance from 1996 to 2000. In creating the following chart, I built a composite of housing stocks using Toll Brothers (TOL), Ryland Group (RYL), KB Home (KBH) and DR Horton (DHI) because the HGX Index was not launched until 2002. I also adjusted the NASDAQ price ratio so it would be comparable to the housing composite on a percentage basis.
In addition to the "bubble" chart correlation, the housing stocks are also registering DeMark sell signals. The HGX index has registered a TD Sequential ™ 13 on its monthly chart (not shown), which indicates that the trend has a high probability of reversing in August. The NDX index registered a similar TD Sequential ™ on its monthly chart in March 2000.
While the fundamentals for the companies have been stellar, the homebuilder stocks are trading at historically high valuation ratios, indicating much of the good news is being discounted already. While Price/Earnings ratios have remained low because of strong earnings growth, Price/Sales ratios have almost tripled since 2000 and are almost twice as high as previous peaks. And while investors could pay higher earnings multiples for the homebuilders, in turn driving the stocks higher, it seems unlikely they would pay higher multiples on what could be "peak earnings."
The homebuilders could be achieving "peak earnings" because several signs indicate the hot housing markets around the country are slowing. I believe much of the recent home price appreciation has been driven by low short-term rates, which encouraged buyers to use short-term adjustable rate mortgages. But the affordability of housing has decreased since short-term rates have increased over the past year. In addition, yesterday’s reiteration by the Federal Reserve that monetary policy remains "accommodative" indicates the Fed will continue raising rates until it feels it has reached a more "neutral" rate.
It seems higher rates and rising prices have already begun to have an effect on slowing the housing market. Recent news articles in the Washington Post, Orange County Register and Las Vegas Review-Journal all discuss weakening trends in their respective housing markets.
So while this might not be "the top" for the homebuilder stocks given their strong momentum, it seems that both the technicals and fundamentals are indicating the risks are currently skewed to the negative side.
