Homebuilder Stocks: Don't Chase the Mojo

NEW YORK ( TheStreet) -- I cannot find an industry that has performed better than the homebuilders since the market lows of Oct. 4, 2011. The PHLX Housing Sector Index is up an incredible 89.3% since bottoming on Oct. 4, 2011, which includes a gain of 35.5% year to date.

Monday we learned that the National Association of Home Builders /Wells Fargo Housing Market Index rose six points to 35 in July, and Wednesday morning we learned that housing starts rose a better-than-expected 6.9% in June, to an annual rate of 760,000 units. The important single-family starts rose 4.7%, to an annual rate of 539,000. Building permits fell 3.7% to 755,000.

With the six-point rise to 35, the NAHB/HMI notched its largest one-month gain in nearly a decade, with the index at the highest level since March 2007, before we knew we were in the "Great Credit Crunch".

The strong rise in the HMI is evidence that builder confidence is on the rise, but remember that a reading has to be above 50 to describe the market for new homes as "good". At 35, HMI is below 50 and thus homebuilders still view the market for new homes as "poor".

RealtyTrac recently reported that there are 5.6 million mortgages that have just entered delinquency or are in foreclosure. With this overhang, the builders will continue to have issues with poor appraisals. In addition, home buyers face continued tight lending standards when applying for a mortgage.

The HMI 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.

The Housing Market Index peaked at 72 in June 2005. On June 21, 2005, I wrote this for RealMoney.com: "Homebuilders' Charts Testing Hearts" .

Back on June 21, 2005, I viewed the homebuilders as having the hottest momentum (mojo) in the stock market at that time. A ValuEngine screening of eight homebuilder stocks showed them all overvalued, with parabolic chart patterns on these names.

Here's the table, Key Metrics for the Homebuilders, as it appeared in my June 21, 2005 story.

Here's the table Key Metrics for the Homebuilders at Tuesday's close, July 17, 2012.

Centex was purchased by Pulte Homes in 2009 for $1.6 billion.

Despite the strong stock performances for the homebuilders since October 2011, the stock prices today are significantly lower than in June 2005.

Three of seven homebuilders are overvalued today (DHI, LEN & TOL), while all eight were overvalued in June 2005.

I did not use ValuEngine ratings in 2005, but today BZH is rated a sell (2-Engine), while DHI, LEN, RYL & TOL are rated buy (4-Engine). KBH & PHM are rated hold (3-Engine).

Sell-rated BZH has traded lower over the past 12 months, with hold-rated KBH up just 11.1% compared to the solid double-digit gains from the others.

Today the P/E ratios are out of whack, while they were reasonable in June 2005.

Using the Value Levels, Pivots and Risky Levels:

Value Level - The price at which to buy on weakness during the time frame referenced; W-weekly, M-monthly, Q-quarterly, S-semiannual or A-annual. You buy on weakness to establish or add to a long position, or cover a short, or become less short.

Pivot - A price that should be a magnet during the time frame referenced; W-weekly, M-monthly, Q-quarterly, S-semiannual or A-annual.

Risky Level - The price at which to sell on strength during the time frame referenced; M-monthly, Q-quarterly, S-semiannual or A-annual. You sell on strength to establish a short position or add to a short position, or remove a long position, or become less long.

I advocate the use of GTC Limit Orders to add to long positions or become less short on share price weakness to the Value Levels. Traders should enter GTC Limit Orders to reduce the long positions or to add to a short position on strength to Risky Levels.

Back in June 2005, I correctly worried about a bubble in homebuilder stocks and here's the monthly chart for Toll Brothers from back then.

The daily charts for the top performing homebuilders today show potential mini-bubbles.

To review my "Buy and Trade" methodology, please read " Suttmeier's 'Buy and Trade' Investment Strategy ".