Housing 'Recovery' Built on Wishful Thinking

This column was originally published on RealMoney on Jan. 17 at 11:06 a.m. ET. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Lately I have been getting a lot of requests for an update on the homebuilders. Over the past year or so, I have written about this industry group more than I want to remember and have had a pretty good handle on the health of the industry.

For example, last September I wrote a piece about the inevitability of the recent rash of writedowns in asset values. Prior to that article, I observed that the prolonged bull market has created a lot of high-ranking executives with absolutely no experience in managing a downturn in housing demand. I haven't seen anything that prompts reconsideration of that view.

I just haven't bought into the notion that the housing industry has bottomed. The market anticipates future developments, and I've heard the same sentiment over and over again: The market will improve in late 2007. I don't believe that. I think that the widespread optimism for a late-2007 recovery is a big pile of wishful thinking. But I do believe that this optimism will be enough to buoy the stocks into the latter part of the year, at which time the market will realize that it was a bit too optimistic.

Once the "late 2007 recovery" is off the grid, will the stocks then sell off? Probably not. The forecasts for a housing recovery will simply be pushed out for another six to nine months. And who wants to sell the group then -- when a recovery is, once again, right around the corner? I think a bona fide recovery is still a ways off. After all, homebuilders are finally getting around to simply dropping prices rather than parking BMWs in the driveway with college tuition checks jammed in the glove box.

With that being said, one undeniable truth is this: I have been out of sync with the homebuilding stocks. My analysis of the industry has been pretty solid, but I have not made you any money. I never really embraced the rally that began last July and have been on the wrong side of the "be right or make money" equation.

Now that I have that off my chest, I feel better. So let's look at the charts of the homebuilding stocks without thinking about the lousy state of the business right now. One theme persists through all of these charts: The stocks are right at support. If you're a bull, buy 'em now. If you're a bear, sit tight and wait for support to break down.

This weekly chart of Hovnanian (HOV Quote) shows a rising wedge created by higher highs and lows. At some point, the bulls will fail to print a higher high, and that's when HOV is most likely to roll over. But the stock is at support right now and offers a low-risk buying opportunity. And if you're long, consider the December high as the benchmark for the next rally. Without a new high, HOV is likely to break down from the current channel.

Centex (CTX Quote) is also climbing in a series of higher highs and lows, but its channel is a bit more constructive than that of HOV. Because support and resistance are generally parallel to each other, it will take less buying pressure to print a new high than in the wedge formation we just saw in Hovnanian. If you're long, try keeping a stop back below $50. That gives the stock a bit of room to move without risking too much capital on the trade.

Pulte Homes (PHM Quote) has been in a steady uptrending channel with well-defined support and resistance. Since July, the stock has been printing higher highs and higher lows. I see the upside for the next advance to be right around $35 -- which is right where the stock peaked in October and December. I'd keep my stop back below the November low, just in case support breaks down.

D.R. Horton (DHI Quote) has been stair-stepping higher in a series of 10% moves. I've drawn the short-term support for the stock at around $26. As long as DHI stays in the channel, you want to be long. But if support breaks down, I'd move to another neighborhood.

Toll Brothers (TOL Quote) has been climbing higher in a fairly tight range and is now at the bottom of the channel. I think $30 is a critical level and needs to be respected. Notice how the $30 level has acted as support in early 2006 and as resistance last October. So far, the stock is holding up at $30. Until that changes, I'd stay long.

Be careful out there.