The Secret Market-Beating Sector

The media remains fixated on the Dow Jones Industrials and the S&P 500. There is a celebration every time one of these indices makes a new high. However, there is one sector that continues to outperform both of these markets, and it is completely ignored. Can you guess what sector that is? OK, I will give you a hint: It's the most hated sector in the market.

Still don't know? It's the homebuilders! I started talking about the bottoming in the homebuilders back in September when I said that the bottoming process in the sector may seem odd since the news has continued to be so negative.

Everyone knows existing-home sales have been declining for months, and builders are stuck with large inventories. The news media and economists continue to bash the sector, saying that the worst is still to come. However true that may be, homebuilding stocks continue to rise as their earnings and earnings expectations continue to decline.

That may seem strange to most investors, but as I have said in past columns, it is more important to pay attention to how a stock reacts to the news, not the news itself. If a stock or a sector has been in a sustained downtrend and then stops going down or goes up on bad news, that's a good sign that a tradeable bottom is likely in place.

This is not the first time that this has happened with the homebuilders. Back in 1981-1982, we saw them go through the same cycle. The homebuilders got extremely cheap because earnings had fallen by 50%, and investors knew their earnings would continue to go down. However, in the midst of all this bad news, housing stocks started to rise, going up fivefold in less than three years.

I'm not saying the same thing is going to happen this time, but the homebuilders continue to defy logic as they move steadily higher each day. They do this in the face of analysts arguing that the "housing bubble" has burst and that these stocks are going to go much lower.

All right, let's take a look at the photo gallery.

In my Sept. 26 column, I said that the Philadelphia Housing Sector Index looked like it was preparing to challenge the July highs. I stated that if it broke above this level, it would have a good shot at the 240 area. That is exactly what happened, and after a brief retracement in that area, it continued to shoot higher, moving up almost 21% since then and now beginning to become extended.

I also talked about the Dow Jones Home Construction Index, stating that there was some heavy institutional buying going on throughout September and that that may be signaling better times to come. Although the index has been a little erratic, it continues to move higher from solid institutional support.

On Thursday, we saw Hovnanian Enterprises (HOV - commentary - Cramer's Take) stock gap above the 50-day moving average on heavy volume. Then on Friday, it followed through, moving up over 5% for the day. It will now have to contend with the December high of $38.66. If HOV can consolidate in that area, there is plenty of room for it to move higher.

Lennar Corp. (LEN - commentary - Cramer's Take) has also moved out of a basing pattern and looks like it is going to make another run higher. It needs to consolidate somewhere between here and the $60.00 area in order to build a solid enough base to break the $62-$66 resistance levels.

D.R. Horton Inc. (DHI - commentary - Cramer's Take) has also made some solid price gains over the past couple of weeks. It is now quite extended off of support and the 50-day moving average. It would be positive for the stock to consolidate in this area before attempting to move any higher.

Every time I have mentioned the homebuilders since my initial September column, I have received emails from readers arguing that the sector is still doomed. This is when a sector really gets my attention. If everyone is negative and the news is bad, but the stocks continue to go up, it can be a formula for tremendous profits.

At this point, most of the stocks in the housing sector are overextended and due for a pullback. If you've taken a position, it may be a good time to take some profits off the table. Only time will tell whether this sector will re-enter another bear market, but until it breaks below its 50-day moving average, the trend is still higher.

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At time of publication, Manning held no positions in the stocks mentioned, although holdings can change at any time.

Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Manning appreciates your feedback; click here to send him an email.