Second Warning: Avoid This Entire Industry

BOSTON (TheStreet) -- Hovnanian (HOV) and other homebuilder stocks have risen on the belief that the housing market has bottomed after five years of declines. Problem is, they may have climbed too fast.

My colleague Mike Baron noted last night that the latest surge in homebuilder stocks came on the back of a report from the National Association of Home Builders, which said its survey for January had the highest reading since June 2007.

The good news didn't carry over into Thursday, though. While investors found out this morning that the rate on 30-year fixed mortgages is the lowest its ever been, the bad news was that housing starts dropped in December by 4.1%, a woeful finish to the worst year ever for construction of single-family homes.

Perplexingly, many homebuilder stocks continued their recent surge. In addition to Hovnanian, KB Home (KBH) and Beazer Homes (BZH) were among several housing companies up at least 1% Thursday.

As it turns out, many homebuilder stocks that have rallied big this year are very much in overbought territory, and investors would be wise to think twice about buying now.

Bespoke Investment Group late Wednesday noted that the SPDR S&P Homebuilders ETF (XHB), which is up nearly 12% this year, is the most overbought ETF as it is currently more than 13% above its 50-day moving average. That beats out other ETFs that track banking, materials, clean energy and even Brazil.

UBS analysts were all over this idea today, coming out with a research note that asserts that the robust housing recovery many are expecting based on recent economic reports "is overly optimistic."

UBS says underwriting is unlikely to materialize given regulatory uncertainty as well as the macro headwinds, presumably referring to the worries over the European debt crisis and the potential for a global recession. Additionally, the transition of foreclosures from owner to renter occupied remains gradual. Lastly, UBS says it expects that government policy will focus more on mass refinancing as an economic stimulus, rather than increasing the homeownership rate.

Because of that view, UBS analysts swung the ax at several homebuilder stocks Thursday, downgrading D.R. Horton (DHI), Toll Brothers (TOL) and Lennar (LEN) to neutral and both KB Home and Meritage (MTH) to "sell," citing valuation concerns.

Last week, Goldman Sachs analysts made a similar call to avoid the homebuilder rally. But since then, many housing stocks have continued to rise.

UBS analyst David Goldberg, though, concurs with Goldman's view that the housing market isn't improving fast enough to justify such rich valuations.

"In our view, the earnings power needed to justify these levels will only be realized in a robust recovery," Goldberg writes. "Said differently, we believe housing has bottomed and that an improvement is unfolding, we just don't believe the rate of acceleration will be sufficient to justify upside for most of the group."

-- Written by Robert Holmes in Boston.



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