Homebuilder Stocks Break Out Again

NEW YORK ( TheStreet) -- Homebuilders rallied on Thursday after we learned that building permits in July rose 6.8% to a seasonally adjusted annual rate of 812,000, the highest reading since August 2008.

This followed Wednesday's press release from the National Association of Home Builders, which reported its Housing Market Index rose by two more points to a reading of 37.

While these trends are considered positive, the market for new homes is far from a normal recovery.

Below the positive permits data, housing starts slipped 1.1% in July to a seasonally adjusted annual rate of 746,000 units. This weakness resulted from a 6.5% decline in the construction of single-family homes, which fell to an annual rate of 502,000, down from a two-year high set in June. The important single-family home segment represents 70% of the market.

The rise in the NAHB Housing Market Index, or HMI, to 37 followed a strong six-point rise in July, but the index remains below its "normal" reading of 50. A reading above 50 is "good" and a reading below 50 is "poor".

In its press release, the NAHB cited the positive trends in this data including improved readings for "current sales conditions" up three points to 39, "traffic of prospective buyers" up three points to 31, and "sales expectations for the next six months" up one point to 44. All measures for the HMI were at their highest levels in more than five years.

From the builder's perspective, these trends are positive, but keep in mind that the housing market is far from normal. I view the rise to a "less poor" reading of 37 as indicating that the homebuilders are somewhat less pessimistic.

Digging into the current report for housing starts we find they rose only in the Midwest and fell elsewhere around the country. At 746,000 units and 812,000 permits, the rate of construction is roughly half the normal pace of the 1.5 million units considered healthy.

At the January 2006 peak of the housing bubble the pace was an astonishing 2.3 million. At the low point in April 2009 Housing Starts were just 478,000 so we up 56.1%, which is a start, but is it sustainable?

Anecdotally, homebuilders still talk about overly tight lending conditions for both the builders and potential buyers of new homes. With defaults and foreclosures on existing homes still elevated, the home appraisals are dragged lower by short-sales and sales of bank-owned homes.

The NAHB HMI peaked at 72 in June 2005, which is when I predicted a peak the share prices for the home builders. The index has been below 50 since May 2006, and home prices peaked in June/July of 2006. The low for the index was 8 in January 2009.

Nonetheless, the stock market viewed these data as extremely positive for the homebuilder stocks as the PHLX Housing Market Index set a new year-to-date high at 144.74 Friday morning.

The HGX (144.05) is up 95.5% since October 2011, and up 39.9% for the year to date. This index tracks stocks in the home construction industry including the homebuilders.

The weekly chart below is positive with overbought momentum (12x3x3 weekly slow stochastic), and with HGX above its five-week modified moving average at 136.45, and well above its 200-week simple moving average at 102.12. My quarterly and annual value levels are 135.17 and 122.53 with a monthly risky level at 152.09.

The above table shows data from www.ValuEngine.com covering 10 of the homebuilder stocks.

Reading the Table

OV/UN Valued -- The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage according to ValuEngine.

VE Rating -- A 1-Engine rating is a Strong Sell, a 2-Engine rating is a Sell, a 3-Engine rating is a Hold, a 4-Engine rating is a Buy and a 5-Engine rating is a Strong Buy.

Last 12-Month Return (%) -- Stocks with a red number declined by that percentage over the last 12 months. Stocks with a black number increased by that percentage.

Forecast 1-Year Return -- Stocks with a red number are projected to decline by that percentage over the next 12 months. Stocks with a black number in the table are projected to move higher by that percentage over the next 12 months.

Value Level: The price at which to enter a GTC Limit Order to buy on weakness. The letters mean; W-Weekly, M-Monthly, Q-Quarterly, S-Semiannual and A- Annual.

Pivot: A level between a value level and risky level that should be a magnet during the time frame noted.

Risky Level: The price at which to enter a GTC Limit Order to sell on strength

Analysis of the Homebuilders

Looking at the overvalued/undervalued data six of the home builders are overvalued, with Lennar ( LEN) overvalued by 35.4%.

There are two "2-Engine" sell-rated stocks, one "3-Engine" hold-rated stocks and seven "4-Engine" buy-rated stocks.

Look at the tremendous performance of these stocks over the past 12 months led by Pulte Homes ( PHM) with a gain of 181.99%.

Three of the stocks are projected to be lower over the next 12 months led by Beazer Homes ( BZH), projected to be down 9.4%. The upside leaders are projected to be Lennar and Ryland Group ( RYL), up by 10.9% and 10.8%, respectively. This projected performance is well behind the gains of the past 12 months.

A major warning comes from the P/E ratios where ValuEngine cannot compute for four stocks and with the others elevated by between 30.4 times and 174.7 times 12-month forward estimates. Longer-term homebuilders statistically had high single-digit P/E ratios.

An issue facing the housing market is how to help potential move up buyers who have an exiting home to sell. If the homeowner has one of the 24% of all mortgages that is underwater, selling that home becomes problematic. There could be a program to offer the forgiveness of principal, but that would not be in the best interest of the lender. This leads to the ongoing debate about principal reductions to help families stay in their homes.

The White House, through the U.S. Treasury, wants the Federal Housing Finance Agency to direct Fannie Mae ( FNMA) and Freddie Mac ( FMCC) to implement the Home Affordable Program Principal Reduction Alternative, or HAMP PRA. To his credit, the acting director of the FHFA, Edward J. Demarco concluded that the "anticipated benefits do not outweigh the costs and risks" and that the "FHFA concluded that HAMP PRA did not clearly improve foreclosure avoidance while reducing costs to taxpayers relative to the approaches in place today."

One thing Congress can do to help an underwater homeowner in the sale of a home is to allow the out-of-pocket additional loan principal payment, required to pay off the mortgage, be considered a long-term capital loss on federal taxes.

At the time of publication the author had no positions in the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.

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