It’s Too Early to Bet on a Rally in Homebuilders

Housing stocks have further to fall.

Even if the seasonal bullishness plays out this year, and we get a rally in the broad stock market, the homebuilding sector is not likely to participate.

The setup in the S&P Homebuilders ETF (XHB) still looks bearish.

Here’s the chart…

We turned bearish on the homebuilders in early September. The stocks had been rallying in anticipation of the FOMC cutting interest rates – which would lead to lower mortgage rates and more home sales. That’s bullish for the stocks.

So, investors were piling into the builders prior to the event.

XHB rallied from $93 per share in June – when rumors of a rate-cutting cycle first began – to $119 in September. That’s a 28% gain in just three months.

But, we were skeptical of the move. A lower Fed Funds target rate does NOT always lead to lower mortgage rates. So, we argued the rally in the homebuilders was based on a false premise. The stocks were likely headed lower.

Indeed, XHB peaked just prior to the Fed rate cut. It would decline 18% over the next two months.

Recently, though, the housing stocks have come back to life. XHB is up 6% in less than a month. The stock is coiling around its various moving average lines – building energy for the next big move.

And, with the Fed having cut short-term rates once again, lots of financial television talking heads are suggesting the next big move for the housing sector will be higher.

I’m not so sure.

Last month, as XHB fell to a lower low, all of the momentum indicators at the bottom of the chart were making lower lows as well. This action confirmed the downtrend.

The lack of any “positive divergence” suggests that any bounce would be short-term only, and XHB would come back down and make at least one more lower-low. So, it seems to me the next big move for XHB will be to the downside.

The good news for housing bulls, though, is the recent rally was strong enough to pull the momentum indicators off the bottom. Now, if XHB declines to a lower low, the momentum indicators are all likely to make higher lows.

That will create the sort of “positive divergence” that sets the stage for an intermediate-term rally phase.

For now, though, it’s too early to bet on a rally in the homebuilders.

Best regards and good trading,

Jeff Clark
Editor, Market Minute