From 2001 to 2006, the homebuilders sector was one of the strongest performers among all stock sectors. Many of those shares quadrupled over that time. Conversely, over the past five years, homebuilders have been one of the worst-performing sectors.
On December 6, 2006, the SPDR S&P Homebuilders ETF (NYSE:XHB) stood at a lofty $38.65. On Monday it closed at $17.12, a loss of 55%. By comparison, the S&P 500 has lost less than 11% during that same period.
As recently as Oct. 3, the XHB was languishing at only $12.55, a 67% correction from the end of 2006. However, since the October low, XHB is up over 36%. That’s about double the S&P’s rise during the same time frame.
Obviously, homebuilders fortunes are shifting, despite real estate’s never-ending troubles. If you believe the stock market always looks several months ahead, right now the market is projecting that 2012 will be a much better year for this beaten-down sector.
When considering individual stocks within a particular sector, I want to make two decisions. First, is the sector either overbought or oversold? And second, which stocks within that sector have the best relative strength? Many investors fail to consider these factors, and thus often buy the underperforming stocks. Or they buy the better stocks, but near the peak of their bullish move.
With this in mind, let’s look first at the XHB, and consider whether or not now is the time to buy this homebuilder ETF or any of the individual stocks within that sector. The first chart below right shows the XHB, with the RSI (14), MACD (12,26,9), and Full Stochastic indicators.
Since the October lows, the XHB has crossed above both the 50-day and 200-day moving averages. This is clearly a positive, although tempered somewhat by the 50-day still ranging below the 200-day line. Still, the upward direction of the 50-day moving average would seem to indicate it won’t be long before we see the “golden cross” of the 50-day crossing above the 200 day.
Another positive is that after a recent pullback of XHB to 15.00, the MACD has now generated a new buy signal.
However, the RSI (14) at 63.99 and the Full Stochastic reading over 89 are a bit too frothy. An RSI reading above 70, or a Stochastic above 80, is generally considered to be overbought. Although these stocks may have some juice left, when the RSI and Stochastic levels are overbought, the level of downside risk begins to outweigh the upside potential.
So, I’m looking for a healthy pullback on these stocks. But the question remains: Buy the index itself, or look for some individual stocks within the sector?
The advantage of buying the index is the diversity of stocks, which reduces your downside risk. The disadvantage is that the potential opportunity to outperform the index by buying the best individual stocks.
When a sector turns positive, I would rather be in the individual stocks than the index in order to maximize the reward potential. Conversely, if the sector is struggling, it’s safer to own the index. Right now, with the homebuilder stocks beginning to show greater relative strength than the overall market (S&P 500), I’m looking for the strongest stocks within that sector.
How to Find the Strongest Stocks
We begin by comparing several stocks within the homebuilder sector against each other and the XHB by running interactive charts on them. The next chart covers the last three months. Let’s compare XHB with five well known homebuilder stocks: DR Horton (NYSE:DHI), Ryland Homes (NYSE:RYL), Beazer Homes (NYSE:BZH), Toll Brothers (NYSE:TOL), and Hovanian Enterprises (NYSE:HOV).
Clearly, over the past three months, Ryland Homes (RYL: green line) has demonstrated superior relative strength versus both the XHB and the four other homebuilder stocks shown, almost doubling the performance of DHI, TOL, and the XHB.
However, if we were to shorten that time frame to the last 30 days, TOL (19%) and BZH (18%) have slightly outperformed RYL (17%).
Now let’s look at a very short time frame, the last five trading days (the last chart):
Here we see that BZH is a runaway performer, with RYL and HOV in the next best group.
In terms of relative strength, RYL and BZH are the two best performers over the last week, month and three-month period. Another positive about RYL and BZH: Both are showing a large number of insider purchases in the last month.
Therefore, these are the two homebuilder stocks I want to own going forward. However, as mentioned earlier, I’m looking for these stocks to pull back before I purchase them. RYL could easily drop from its current price of $15.50 to its 200-day moving average at $14.51. BZH, currently at $2.41, could easily slide to the $2 to $2.10 range.
When you see big moves like these stocks have had, it”s tempting to want to chase them, but the more prudent thing to do is to wait for a pullback, and then build a position over a few days.
So, despite all of housing’s troubles over the past five years, the market is clearly looking ahead to at least somewhat sunnier days.