Homebuilders: Cheap but Not Easy

The home also looks set to become a drag on consumer spending, as about $265 billion of adjustable-rate mortgages are up for initial resets over the next 12 months, according to a recent report in the St. Petersburg Times, and the total of adjustable mortgages are $565 billion. This will result in a $12 billion increase in interest payments.

This is a tough environment to be investing in the homebuilders, but they remain cheap enough for the long-term investor to maintain a core holding. The allocation of capital to this industry should be 25% to 50% of one's maximum allocation to this sector.

After the close on Wednesday, Centex(CTX) and Pulte Homes(PHM) reported quarterly earnings. Both reported higher profits, but Centex missed EPS estimates while Pulte beat its number. Shares of Centex plunged 7% in after-hours trading. Both homebuilders indicated that orders stumbled 11% in the quarter, a clear sign that housing market is faltering.

This morning, Beazer Homes(BZH) reported quarterly earnings with a similar theme -- it beat earnings expectations but saw a 19% decline in orders.

With forward P/E ratios in the 5.7 to 7 range, the homebuilders are cheap and remain rated strong buy and buy, according to ValuEngine. Since my last column on the group, the yield on the 30-year bond is up 50 basis points to 5.20% this morning, and this has put a huge drag on the fair value of all the homebuilders. I would be more upbeat on the group if the stocks were 20% or more undervalued, but that's just not the case.

The weekly chart profiles are mixed but will shift to negative on all if Pulte ends the week below its five-week modified moving average (MMA) at $39.49, and if Toll Brothers(TOL) ends the week below its five-week MMA at $33.91.

The Homebuilders The group shows up undervalued, but don't be lulled by that.
Company Name	Wednesday Close	Rating	(-UV) / OV %	Fair Value	Momentum	5-Week MMA	Value Levels	Pivots	Risky Levels
Beazer Homes (BZH)	$61.25	S Buy	-10.40%	$68.37	DM	$65.79	54.97 S	59.59 A / 62.68 S	69.29 Q
Centex (CTX)	$60.75	S Buy	-18.10%	$74.15	OS	$64.07	52.95 A	61.24 A	65.99 M / 69.86 S
DR Horton (DHI)	$31.33	S Buy	-16.80%	$37.67	DM	$33.68	25.29 A	30.83 A / 35.26 S	37.80 S
KB Homes (KBH)	$63.25	S Buy	-6.10%	$67.33	DM	$66.78	49.83 A	59.59 A / 66.51 S	73.70 S
Lennar (LEN)	$56.22	S Buy	-13.20%	$64.80	DM	$59.17	43.51 A	57.35 A	64.17 M / 64.43 Q
Pulte Homes (PHM)	$39.04	S Buy	-9.20%	$43.00	RM	$39.49	28.60 A	34.88 A / 37.26 S	43.04 S
Ryland Group (RYL)	$65.24	S Buy	-6.60%	$69.87	DM	$69.60	59.15 Q	70.16 A	75.98 M / 78.64 A
Toll Brothers (TOL)	$33.34	Buy	-2.70%	$34.27	RM	$33.91	25.59 A	29.99 A	36.98 S
Key: OB, overbought; DM, declining momentum; RM, rising momentum; OS, oversold; M, monthly; Q, quarterly; S, semiannual; A, annual. A value level is a price at which my models project that buyers will emerge; a risky level is a price at which investors are likely to reduce holdings, according to my models. A pivot is a value or risky level that has been breached in its particular time horizon; the stock will likely trade around this pivot. Source: Global Market Consultants

Trading Strategy: Investors should adjust holdings of the homebuilders to be 25% to 50% of their maximum allocation. If a stock is below its pivots, reduce holdings on strength to that pivot. If a stock is between its pivots, reduce holdings on strength to the higher pivot. If a stock is above its pivots, reduce holdings on strength to the risky levels, or on a sell stop below the pivots. It's not the time to aggressively add to positions unless there is weakness to a value level at which to rebuild positions.

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