Four Stocks for a Homebuilding Recovery - TheStreet

Homebuilding stocks have been surprisingly resilient in the past few months, and are now setting up to lead the broad market. This quiet turnaround hasn't attracted much financial-media attention, offering early birds a great opportunity to get positioned before the rest of the flock realizes an important sector advance is getting underway.

The group's strength lends major support to the bullish view that we're grinding through a minor respite, ahead of a stronger economic recovery later this year, and into 2011. It's even more remarkable given the near certainty of less accommodating interest rates in the months ahead.

Why do these stocks look so good while the broad market looks so bad? Most homebuilders likely have put their economic houses in order, so to speak. Despite the backlog in unsold inventory, they are starting to raise revenues and profits. In addition, this relative strength also may signal a renewed wave of consumer refinancing, bargain-hunting and outright demand.

That said, I believe it best for readers to use a stockpicker's approach to sector buying, choosing the most favorable opportunities and avoiding chronic underachievers. In that regard, mediocre-buying patterns in the past few months rule out

Pulte Homes

(PHM) - Get Report

,

NVR Corp

(NVR) - Get Report

and

Toll Brothers

(TOL) - Get Report

.

The

SPDR S&P Homebuilders ETF

(XHB) - Get Report

might look unremarkable at first glance, but there are good things happening below the surface. First, note how selling pressure bottomed out in October, with quiet accumulation into January. Then, despite seven above-average sell-off days in 2010, accumulation and price have held up extremely well, pointing to underlying institutional sponsorship.

Second, the fund is turning higher after a five-month test at the 200-day moving average. The top of this consolidation pattern, at $16.75, is now a major inflection point in evaluating the sector's progress. That level has converged with a three-year down trendline (not shown) and the 50% retracement of the bear market selloff. This raises the odds that a breakout will yield a major rally that reaches the mid-$20s and recaptures 100% of that nosedive.

Finally, keep in mind: The fund is an equal-weighted instrument that includes two non-homebuilders,

Home Depot

(HD) - Get Report

and

Lowe's

(LOW) - Get Report

. Those issues occupy the 10th and 16th slots in relative strength, out of 18 fund components. This tells us that "real" homebuilders are outperforming the fund, adding another layer of bullish support.

Lennar

(LEN) - Get Report

stunned analysts last week when it announced the purchase of distressed and nonperforming loans from 22 failed banks. While it might sound counterintuitive, the stock rocketed after the news because the bold move suggests speculation is finally returning to the real-estate market.

This sector survivor leads the homebuilding fund in overall relative strength, and has set up a multiyear cup and handle pattern, with resistance above $17.70. A breakout could yield a strong uptrend that lifts price into the low-$30s prior to year's end. This healthy profit potential is the reason I'm calling Lennar my top sector pick.

Meritage Homes

(MTH) - Get Report

showed great resiliency in the early phase of the housing collapse, but finally succumbed in 2008. It emerged from oblivion last year, posting a May high near $24 and dropping into a sideways pattern that's still in place. Like other homebuilders, it has been ticking higher since December, and is now setting up a test at key resistance levels.

Accumulation has been escalating in recent weeks, suggesting the stock has now completed a recovery phase and is ready to embark on a strong uptrend. A rally over $24.35 should trigger a fast-moving breakout that completes a round trip to the September, 2008, swing high near $30. Progress could pause at that level, ahead of a final impulse that reaches the unfilled June, 2007, gap at $33.

Standard Pacific

(SPF)

is a $4 stock, just like its competitors,

Beazer Homes

(BZH) - Get Report

and

Hovnanian Enterprises

(HOV) - Get Report

, but it's the only one of the group I'd recommend buying here. My bullish reasoning is simple: Unlike its low-priced cousins, accumulation and price have held up exceptionally well since the initial recovery wave topped out in the third quarter last year.

This pattern might look like a carbon copy of the homebuilding ETF, but anyone buying the stock needs to exercise a dose of realism. A breakout above the August high at $4.59 is unlikely to trigger a rally into double digits anytime in 2010. However, a steady uptrend into multiyear resistance near $6.70 might still book a 40% to 50% gain. Not bad at all.

Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

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

Alan Farley is a private trader and publisher of

Hard Right Edge

, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of

The Daily Swing Trade

, a premium product from TheStreet.com that outlines his charts and analysis. Farley has also been featured in

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,

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,

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,

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,

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,

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and

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. He has written two books:

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and

The Master Swing Trader Toolkit: The Market Survival Guide

, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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