A dramatic slide in housing starts last month and a fifth interest rate hike by the Federal Reserve on Tuesday have left Wall Street bears in no doubt that homebuilders' best days are over.

But the pessimists have been wrong for a long time.

Indeed, the Philadelphia Housing Index has doubled over the past two years as calls for a sharp slowdown proved to be unfounded. The group has climbed 27% this year and is up 18% since TheStreet.com wrote a bullish article on the sector in March .

"Somehow, the bears continue to miss the point that this is a consolidating industry, that the big guys continue to get market share from the little guy," said Ron Muhlenkamp, founder and president of the Muhlenkamp fund.

Large builders now control more than 20% of the market, up from just 5% in 1991, and analysts say that could rise to 50% going forward.

Muhlenkamp said the strength of the housing market has actually surprised him this year and he has been calling for starts to flatten out. Still, he thinks sales will continue to grow at a healthy pace over the next few years.

Shares of homebuilders fell Thursday after the Commerce Department said housing starts plunged 13.1% in November to an annualized rate of 1.77 million units. That was the steepest decline in 10 years and the lowest level since May 2003. Building permits, a gauge of future activity, also declined to 1.99 million units.

"While we have noted the potential for a housing slowdown for some time ... the magnitude of the November decline is surprising," said Goldman Sachs economist Bill Dudley.

Both single and multifamily starts were down, and all four major regions of the country posted similarly steep declines, he said.

Still, housing starts are volatile from month to month, and though building permits did fall last month, they remain at a very healthy level and signal that a rebound is likely to come in December.

"There is no reason to think this marks the start of a sustained slowing in housing construction," said Ian Shepherdson, chief economist at High Frequency Economics. "Sales have to slow first, and there is no sign of that yet."

Last week, the National Association of Realtors revised up its estimate for existing- and new-home sales in 2004. The association expects 6.58 million existing-home sales and 1.18 million new-home sales this year, both record levels.

In 2005, home sales are expected to fall slightly but remain high by any historical measure. The median existing-home price is projected to rise 5% and the typical new home price is projected to grow by 5.8%. This year, prices for new and existing homes rose an estimated 8.9% and 7.9%, respectively.

"There is a chronic shortage of product and as long as prices go up faster than the rate of inflation, we can be reasonably sure that demand is still strong," said Larry Horan, an analyst at Parker Hunter who has been following the industry for 30 years. His firm has no banking relationship with companies in the sector.

A more disciplined approach to home building and an increasingly lengthy and costly land approval process mean supply is tight in the U.S. while demand has been rising, thanks to a growing population, analysts say.

In recent days, homebuilders have posted impressive quarterly results and raised their estimates for fiscal 2005. After the bell Thursday, KB Home ( KBH) easily beat analysts' fourth-quarter earnings expectations and raised estimates for fiscal 2005. The company earned $4.42 a share in the quarter and expects to earn $14.50 next year, up from an original estimate of $14.

Earlier in the week, Lennar Corp. ( LEN) boosted its earnings estimates for next year, citing an order backlog of $5.06 billion. In its fiscal fourth quarter, the company posted a 34% increase in earnings, saying demand for homes was strong. Toll Brothers ( TOL) and Hovnanian Enterprises ( HOV) also raised their projections for 2005 amid a solid backlog of orders.

"These are much better run companies than they used to be," Muhlenkamp said, noting that the industry's return on equity is around 18% to 20%.

Among Muhlenkamp's top holdings are NVR ( NVR), Centex ( CTX) and Meritage ( MTH).

One of the major concerns among housing bears this year has been the direction of interest rates. Over the past six months, short-term rates have doubled, and the Fed has shown no sign of ending its tightening campaign.

Still, mortgage rates, which are tied to the 10-year Treasury, are actually down from where they were last year. According to Freddie Mac, the average 30-year fixed-rate mortgage stood at 5.68% in the week ended Dec. 16, down from 5.71% the week before and 5.88% in the same week a year ago.

Horan said the yield on the 10-year note would need to rise "materially" above 5% to have any impact on demand. While many traders think that is likely to happen next year, others think it unlikely. The yield was last sitting at 4.19%.

"The risk reward potential on the sector is good," Horan said, noting that the stocks continue to trade at around 8 or 9 times earnings.

"Any other industry with their numbers would be selling at 15 to 20 times earnings," added Muhlenkamp. "So they have a long way to go."