Homebuilder stocks rallied Wednesday after the Federal Reserve's chairman said inflation is moderating, and government data showed new housing starts fell in June, which could help ease the inventory overhang in the U.S. housing market. But the sector's rally may simply be a "dead-cat bounce," which occurs when there is a temporary recovery from a prolonged decline, after which the group continues to fall. One hedge fund manager who invests in the space says Wednesday's action in builder stocks was likely a "short-covering rally" in reaction to Federal Reserve Chairman Ben Bernanke's testimony before Congress, which boosted the entire market. The manager points out that some of the builder names that saw the biggest bounce on the day were those with heavy short interest -- such as WCI Communities ( WCI), which jumped 7.7% The entire homebuilding group -- which had fallen about 15% since the end of last week -- rose on Wednesday. The rally may have also been helped by Ryland's ( RYL) earnings report. Even though Ryland reported a 39% order drop and cut its earnings guidance for the year, investors may have focused on the fact that the company's second-quarter earnings beat analysts' mean estimate. "It's a little bit of a relief rally," says Jack Lake, an analyst with Victory Capital Management, which owns builder stocks. "I don't know how long it persists." Whether the market perceives the Federal Reserve is close to the end of its rate-hike campaign could be a key consideration for the future performance of the group. Consumer-related stocks such as homebuilders and retail companies tend to outperform once the Fed either stops raising or cuts rates, Lake notes. Builders lately have been trading close to their book values, with some trading below. Historically, such levels have also been good points at which to buy the group, Lake says. Not everyone agrees, of course, and some analysts point out that the group traded down to 0.6 times book in the late 1980s, when the housing market tanked.
A.G. Edwards analyst Greg Gieber, who counts himself a bear on the sector, says there is "no urgency in buying homebuilder stocks." "There is a risk of a bear trap here, or a dead-cat bounce," he says. "These stocks will not turn until we get to the end of inventory liquidation, and I don't think we're anywhere near there yet." His best estimate is that it will take a year to clear out excess housing inventory. Signs that builders might be acting prudently and not overbuilding showed up in the housing starts data released by the Department of Commerce Wednesday morning. The report said housing starts in June fell 11% from a year earlier to a seasonally adjusted annual rate of 1.85 million. Economists had been expecting 1.9 million starts, according to Reuters. In May, the level was 1.95 million. Building permits for new single-family homes in June were at a rate of 1.4 million, which was 6.3% below the May figure of 1.49 million. Ryland rose 7% Wednesday after its earnings report. The company earned $94.8 million, or $2.03 a share, compared with $104.3 million, or $2.10 a share, a year earlier. Analysts, on average, expected a profit of $1.93 a share, according to Thomson First Call. Gieber believes that Ryland's slight beat is immaterial and said investors should instead focus on the big order drop. For the quarter, new orders for homes fell 39% to 3,023 units, with the dollar value dropping 40% to $890.8 million. In 2005, the company's orders rose 4% -- much lower than some of huge spikes at builders like Pulte ( PHM), where orders rose 17%. Ryland's orders are "falling sharply off a peak that is not as high as other builders," says Gieber, who rates Ryland a sell.
Ryland's backlog at quarter-end was valued at $2.5 billion, an 18% decrease from a year earlier. Gross profit margins on home sales in the quarter averaged 23.2%, down from 24.5% a year earlier. The drop was primarily due to $20 million of inventory write-downs and increased sales discounts. The company cut its full-year earnings guidance to a range of $7.75 to $8.25, down from its late May forecast of $8.50 to $9 per share. Analysts expect a 2006 profit of $8.03 a share. In a research note, Bank of America analyst Daniel Oppenheim said the full-year guidance looks optimistic. He expects further deterioration of housing fundamentals into July and expects Ryland to eventually cut its guidance again, closer to his $6.95 estimate. Builder stocks could be set for more action Thursday, with M.D.C. Holdings ( MDC) and D.R. Horton ( DHI)set to report their results.