The behavior of housing stocks this year has disappointed many traders who are just now attempting to play the housing recovery. This lackluster action in housing-related stocks provides an interesting case study of price charts leading fundamentals.
One of the bedrock principles that technicians tout as an advantage to their methodology is the notion that stock charts lead fundamental and economic trends.
At its core, the financial market is a discounting mechanism attempting to price in events looming six to nine months in the future. With charts acting as a leading indicator, those who know how to wield them possess an embedded advantage over economists who wait for actual economic data to verify their forecasts before taking action. Analyzing price trends in forward-looking markets, then, is superior to relying on economic statistics that are inherently backward-looking.
For example, consider the timing of the market top in 2007 and market bottom in 2009 compared to when the business cycle actually peaked and troughed. While the S&P 500 Index crested in mid-October 2007, it wasn’t until months later that we found out that December 2007 was the business-cycle peak. Likewise, the S&P 500 bottomed in early March 2009, a full three months before the economic downturn finally troughed in June 2009.
Which brings us back to the housing sector.
After bottoming alongside the broader market in early 2009, housing stocks struggled to regain their former glory. In October 2011, however, amid a housing environment still struggling to capture any kind of upside momentum, the beleaguered iShares U.S. Home Construction ETF (ITB) established a pivotal bottom and started pricing in a housing recovery. During the next two years, ITB rocketed higher from $8.21 to $26.21 — an epic 219% rally.
Once again, price action wins the day. Housing stocks led, with their fundamentals improving well before the economic data confirmed the comeback in the housing industry.
With the recent downturn, though, ITB has given back all of its gains accumulated over the first five months of the year and now sits up a mere 0.2% year-to-date — a pitiful showing given the S&P 500 Index’s 19% gain.
Are housing stocks anticipating a slowdown in the recovery? Or is this just a minor setback, a well-deserved breather after their swift ride to the upside?
A fairly convincing fundamental catalyst for the recent weakness is the sharp rise in interest rates following Bernanke’s infamous tapering comments in May. In a rapid two-month rise, rates climbed 100 basis points from 3.5% to 4.5% before settling back down a touch. While still below their long-term average, the sharp rally no doubt acts as a turnoff for those anchoring their perspective to the recent historic lows in rates.
Thanks to the recent rollover, ITB is sporting an ominous-looking head-and-shoulders topping pattern with a break of the neckline looming closely. Its behavior during the next few weeks should prove quite revealing.
If you’re looking for additional downside in housing stocks, you could buy an Oct 22 put if ITB breaks below neckline support at $21.15. The Oct 22 puts currently are going for $1.30, but will be more expensive by the time ITB triggers.
If you’re still rather sanguine on the housing sector, consider waiting for evidence of a false breakdown below the neckline or a break back above the right shoulder ($24) before entering bullish plays on ITB.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.