Bulls Come Back Hungry

Good economic news and Wal-Mart's guidance spark a post-holiday buying spree.
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A bout of patriotism swept Wall Street on Tuesday as strong data on the U.S. economy and an upbeat forecast from

Wal-Mart

(WMT) - Get Report

ignited Fifth of July fireworks.

The celebration occurred even as oil resumed its march toward $60. After gaining more than $2 per barrel on Friday, crude for August delivery tacked on another 84 cents to $59.59, as tropical storms threatened the Gulf of Mexico, a prominent site for offshore drilling.

Exxon Mobil

(XOM) - Get Report

, which rose 3.14%, helped lift the

Dow Jones Industrial Average

. The blue-chip index also was bolstered by a 3.15% gain in shares of Wal-Mart, finishing the session up 68.36 points, or 0.66%, to 10,371.80.

After all the gloom about a global economic slowdown, investors welcomed signs that the world's largest retailer still can surprise to the upside.

The

S&P 500

gained 10.55 points, or 0.88%, to 1204.99. The

Nasdaq Composite

jumped 21.38 points, or 1.04%, to 2078.75.

Also providing gunpowder was a call from Prudential analyst Ed Keon, who dug out the so-called "Fed model" to point out that earnings as a percentage of stock prices compare well with bond yields.

That augured more pain for bonds, which have been on a downtrend since last week when the

Federal Reserve

dashed hopes it may soon end its rate-tightening campaign. And Tuesday's strong economic data -- factory orders rose 2.9% in May -- did little to revive those hopes.

The benchmark 10-year bond fell 17/32 in price while its yield rose to 4.11%.

Of course, should bond yields -- which are used as benchmarks for mortgage rates -- continue to rise, it would eventually spell trouble for the housing sector, which remains the real motor of the U.S. economy.

And to add insult to injury for housing bulls on Tuesday, CSFB analyst Ivy Zelman downgraded three homebuilders. She cut

KB Home

(KBH) - Get Report

and

M.D.C.

(MDC) - Get Report

to underperform, saying they get too much income from frothy regions like California, Florida, Arizona and Nevada.

She also downgraded

Ryland

(RYL)

to neutral, citing valuation concerns.

After all the premature calls for the end of the housing boom, you have to tip your hat to Zelman for having the courage to downgrade three homebuilders now.

"Investors Gone Wild," was the title of a recent report by Zelman that led to Tuesday's downgrades. "Our thought is that builders that have a higher exposure to markets that benefited from speculation are likely to experience greater headwinds should investor sentiment shift," she wrote.

Yet, judging from the market's reaction to the downgrades, investor sentiment on housing has not shifted much. The Philadelphia housing sector index actually moved higher, adding 0.83%. KB Home finished down 0.81% after opening on a 3.3% deficit.

"Housing continues to impress," says Barry Hyman, market strategist at Ehrankrantz King Nussbaum. "I would expect somewhat of a minor slowdown, but interest rates are still low, and even

if they were to rise to 4.5%, it's hard to imagine that it would blow housing apart."

Other analysts have gotten burned making bearish calls on housing, most notably Stephen Kim of Smith Barney, a respected housing analyst, who made that call in early February before turning around and "getting back on the bus" last month.

Robert Marcin, founder of Defiance Asset Management and a

RealMoney

contributor, noted that Zelman has had a neutral rating on KB Home since 2000, missing a 700% appreciation in price.

Zelman's call, however, was a bit more nuanced than simply turning bearish on housing stocks. For one, she reiterated her outperform rating on

Centex

(CTX)

and raised her price target to $80 from $71 due to the homebuilder's relatively low exposure to the riskier housing markets.

She notes that KB Home's high exposure to risky markets such as Phoenix, for instance, could at the very least spell short-term trouble.

Pricing for Phoenix homes rose 20% in the first quarter from a year ago, and it rose 22.4% from the fourth quarter, according to Lehman Brothers analyst Steven Fockens. "We view such pricing growth as unsustainable and likely driven in part by investment buying," he says.

Fockens remains bullish on housing overall and expects that issues such as the resetting of adjustable rate mortgages and principal amortization on interest-only mortgages won't impact the housing market until 2007.

But, for now, he notes that up to 30% of all home purchases in Phoenix are so-called "investment" or speculative buying, a level matched only by the Florida condo market. Speculators already have been squeezed out of the new-home sales market in Phoenix -- as homebuilders have added clauses to restrict speculation -- and they are now having trouble renting out their purchased homes, making it harder to make mortgage payments.

"If home-price appreciation slows enough that this negative cash flow situation no longer makes sense economically, investors may exit the market en masse, adding a lot of inventory to the market and leading to a less promising pricing environment for builders," Fockens says.

Of course, speculators simply may move to other markets, and the downturn may prove to be temporary. But the move could coincide with a well-deserved breather for homebuilding stocks.

EKN's Hyman recently took a look at the housing sector's behavior, as measured by the Philadelphia index, and believes its most recent move higher is now overdone. "Every time it starts to get 15%-20% above its moving average trend line, it starts to slow and we hit that a week ago," he says.

Likewise, for Hyman, it was the valuation downgrade on Ryland that had most of his attention. "I don't ignore those downgrades, where analysts are trying to keep their models intact and try to measure future value."

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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