Homebuilders have been this year's Weeble. No matter how much the economy

wobbles, they refuse to fall down.

They have a lot to prop them up. The inventory of unsold houses is low and builders are asking for prices that bring growing earnings. Plus, rising unemployment, sagging consumer confidence and mortgage rates that have ticked higher over the past several months have yet to sap demand. Sales of new homes are expected to hit a record level this year. Across the board, earnings are up and fiscal guidance for forward quarters is being reaffirmed.

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Some investors have taken note. Many of the biggest names, like

Del Webb

(WBB)

,

Lennar

(LEN) - Get Report

and

NVR

(NVR) - Get Report

have seen their stock prices increase by more than 15% so far this year. The

S&P Homebuilders Index

, which tracks the sector, has outpaced the broader

S&P 500 by 10% since the year started.

The increases have come as consumers have kept up spending, despite the economic downturn. The

National Association of Realtors

expects new home sales to rise 4.6% this year, to a total of 918,000 units, which would be a new high.

"For the last two years, we've had almost perfect conditions for homebuilding. Earnings were jumping by huge double-digit rates and, at that point, the stocks were only getting a 10 multiple on earnings," says David Weaver, an analyst with

Legg Mason

.

In the high single digits, these price-to-earnings valuations are significantly lower than the average 28 or so of the S&P 500, in part because homebuilders have to deal with seasonal factors that cause their business to ebb and flow throughout the year: Despite an increase of 79.5% over the past five years and performance that places them as the fifth-best sector in the entire S&P universe, valuations are below historical levels.

For the rest of 2001, most analysts have a neutral stance on homebuilders, but not because sales will slide, inventories will rise or even the economy will fall off the table. The determining factor is the direction of mortgage rates.

Homebuilders always make gains when rates fall. This was seen in early March, when the 30-year rate fell from 7.2% to 6.7% and stocks in the sector rose about 20%. It happened again in May, when a sudden rate pullback drove homebuilders' stocks well past their 52-week highs. "We're not likely to see interest rates drop much more; 6.5% is as low as they tend to get, historically speaking," Weaver says.

The

Federal Reserve has been on an aggressive rate-cutting mission since the year began to get the economy back on track. Its efforts are most directly reflected in the price of two-year Treasuries, which rise and fall with expectations about monetary policy. Mortgage rates more closely follow 10-year Treasuries, which are influenced by the bond market's perception of inflation risks. Longer-term bonds have been moving higher, reflecting concerns that inflation may become a problem, and making it more expensive to borrow for a home purchase.

Industry watchers pretty much agree that mortgage rates won't be falling next year. Having sat near 7% for most of 2001, there's not a lot of downside for rates, considering that rates below 7% came about in only three of the last 30 years -- with all of those hitting from 1998 on. Rates never fell below 7% in the 1970s or 1980s.

Hard-Hat Area

Mortgage rates are where the hammer meets the nail for a homebuilder like

Toll Brothers

(TOL) - Get Report

. The company is historically cheap, with a

price-to-earnings ratio of just 8.4, lower than its five-year average of 10 and its 10-year average of 20. Earnings are expected to be solid for the rest of the year; the company reaffirmed its 2001 guidance on May 8. CEO and Chairman Robert Toll is still at the helm of the company he founded with his brother in 1967, the company's balance sheet has a healthy amount of cash and it carries little debt.

But according to

Goldman Sachs'

Christopher Winham, if interest rates don't fall, there's no reason to buy Toll Brothers -- or any of its competitors. "If the market only values these things at seven times earnings in a very robust housing environment, I think things get a little more difficult over the second half of the year, so what is going to be the catalyst to drive those valuations higher?" he asks.

No Inventory Problems Here

The relative strength of the industry could be that catalyst, says Carl Reichhardt, a homebuilding analyst with

Banc of America Securities

, who believes investors have overlooked the rosy outlook for the companies he covers. "The Street continues to miss the boat," he says. "They don't understand homebuilders. There's very little supply. Homebuilders are not building ahead of demand, they're waiting for customers to come to them."

That's a stark contrast to high-tech companies, which have been left with large inventories of premade goods that have to be sold or written off. Orders for houses are booked in advance (known industrywide as backlog) and revenues are recognized only upon delivery of the house, which can take anywhere from three months to a year to complete. So homebuilders are rarely reflective of the current economic situation.

"Homes ordered this summer are typically delivered at the beginning of next year," he says, "As companies receive their order rates from customers, that's going to build a case for 2002 earnings."

Investors seem reluctant to put their money into homebuilders, which can be quite economically sensitive, this year's resiliency notwithstanding. For one, the industry is seen as volatile, with a myriad of markets and products to deal with, more than 20,000 different builders and no dominant, large-cap name to play. The top 20 homebuilders control a mere 20% of the market, a far cry from another high-ticket consumer cyclical cousin -- the automotive industry, which is dominated by a few players. The biggest homebuilding names are themselves mid-cap companies.

The companies in the S&P Homebuilders Index have clocked in with a meager 3.9% year-to-date gain. That pales in comparison to other consumer cyclicals, like retailers, casinos, publishing houses and automakers, which have had double-digit percentage gains as investors bet on a second-half economic recovery.

Not everyone believes investors have overlooked the sector. Some, like Goldman's Winham, say investors have chosen investment opportunities elsewhere, especially after such a solid run-up in the past 12 months. "It's difficult to argue that the market is inefficient," he says. "And that's exactly what you're saying. That the market has this entire basket of stocks mispriced."

The second half will lay it out. If backlogs stay strong, prices firm, demand high and inventories under control, the industry faces a bullish outlook. But without the historical catalyst of sliding mortgage rates in their corner, homebuilders may find that investors once again overlook the sector's strength.