The homebuilding sector has defied skeptics so far this year, as the combination of improving housing market data and investor short-covering has propelled the group to outstanding gains. Year-to-date, the Dow Jones Home Construction Index (DJUSHB) has rallied 32.60%, which places it second among the 99 Dow Jones industry groups. Much of this outperformance has come during the market downturn of the past two months:
With substantial gains already in the books, it’s time to start looking at factors that could derail the story. One of these is the technical picture, which carries above-average importance in sectors — such as homebuilders — where traders are active. A look through the charts of some of the industry’s key players reveals that a number of stocks have begun to print dangerous formations.
A breakdown is by no means inevitable, but investors need to be on alert for indications that homebuilder shares are about to go south. Three charts, in particular, stand out.
First is D.R. Horton (NYSE:DHI), which is the largest U.S. stock in the sector in terms of market capitalization. DHI is still in good shape technically, but this nascent head-and-shoulder pattern could turn dangerous if the lower trendline is violated. This line currently terminates at $14.58, although this level will change slightly each day. That still leaves another 9.5% of downside before DHI breaks down, but a move of this size can happen quickly in this volatile sector.
Lennar (NYSE:LEN), another sector bellwether, is in a similar position. While the stock is far from its lower trendline — currently at $24 — the possibility of a head-and-shoulder pattern, together with weakness relative to a falling 50-day moving average, indicates that the stock is vulnerable to additional downside even though it’s already off more than 12% from its high of mid-May.
Pulte Group (NYSE:PHM) is a third stock that bears watching for a possible head-and-shoulder setup. The neckline is $7.63, established via an intraday low on June 4.
Homebuilders have displayed remarkable resilience in the weak market of the past two months, so it’s entirely possible that the group could continue to surprise via a breakout to new highs if the broader market regains its footing. However, with the economy slowing and the sector already having logged 30%-plus gains on the year, caution is warranted. Monitor these charts carefully in the weeks ahead.