Time to Book Profits on Home Builders

NEW YORK ( TheStreet) -- On April 25, I wrote about the strength in home builder stocks despite what the Federal Reserve described as a housing depression.

Today, we review the housing starts data for April and the National Association of Home Builders Housing Market Index for May. In addition, I will show a graph of the housing sector index that I use to evaluate the risk/reward of the stocks that represent the housing sector within the symbol HGX.

Housing starts rose by 2.6% in April to a seasonally adjusted annual rate of 717,000 homes, which was stronger than expected by Wall Street analysts. The single-family component came in at 492,000 units. The NAHB described this data as "very solid" but at half the pace of a fully healthy housing market. In my opinion, this pace is still within the framework of a depressed market for new homes.

Yesterday, Federal Reserve Governor Elizabeth Duke said that the housing market is slowly mending, but needs a lot of help. Any sustainable housing recovery needs more help from Congress and the banking regulators to stabilize the mortgage market. Governor Duke suggests that banks ease up lending standards for mortgages, which would be a positive step toward attracting buyers back to the market.

The National Association of Home Builders (NAHB) Housing Market Index (HMI) measures builder confidence for newly built, single-family homes on a scale of zero to 100 with a reading of 50 being neutral. This index rose by 5 points in May to 29, after a downward revision to April's reading. The good news is that this is the best reading since May 2007, but the bad news is that it's well below 50.

After a lull in April, potential buyers are window shopping for a new home given record low mortgage rates and the desirability of buying new rather than buying a distressed "bargain" home that faces expensive repairs to return to being livable. The pace of demand for new homes would pick up if potential buyers had access to credit at a reasonable mortgage rate, and if builders had access to new construction and development loans. The NAHB continues to have concerns about inaccurate appraisals on depressed properties, and rising materials prices.

The Housing Market Index peaked at 72 in June 2005, which is when I predicted a peak in the share prices for home builder stocks. On June 21, 2005, I wrote this for Realmoney.com, "Homebuilders' Charts Testing Hearts." The index has been below 50 since May 2006, a month or so before home prices peaked in June/July 2006. The low for this index was 8 in January 2009.

I track the housing market technically by following this weekly chart PHLX Housing Sector Index (HGX) and here's a look at the weekly chart.

Since Oct. 4, 2011, HGX has rallied 82.8% and is up 21.8% year to date. This index tracks stocks in the home construction industry including the home builders. The astronomical performance has occurred despite the fact that 2011 was the worst year in history for new home sales.

Note that HGX is testing its long-term down trend that goes back to July 2005, April 2006 and February 2007. The 200-week simple moving average provides support at 101.49. My annual value level is 122.53 with a monthly risky level at 130.31, which lines up with the down trend.

Conclusion: With HGX testing a major chart down trend going back to 2005, it's time to book profits on home builders and other stocks in the residential construction industries. This includes the home builders rated buy, according to ValuEngine, D R Horton, Lennar, Meritage Homes and Toll Brothers

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