Leave the Homebuilders Alone

 | Sep 23, 2012 | 5:45 PM EDT  | Comments
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The homebuilders sure are tempting, aren't they? The group continues to benefit from spurts of institutional buying as big investors make bets that the builders have survived through the worst of it.

Last week, August housing starts were a bit of a disappointment, coming in at 750,000 units vs. the 770,000 consensus estimate. Starts in July, meanwhile, were revised lower to 733,000 from the prior 746,000. The good news was in existing-home sales, which soared 7.8% from July to 4.82 million units, well above the consensus estimate of 4.58 million.

On Monday, watch for earnings from Lennar (LEN). This is one of several homebuilders whose shares are quite extended at this point after a huge run-up. The last breakout in Lennar was when the stock cleared $30 in late June. We saw an add-on buying area when it found support at its 10-week moving average in August and broke above $31.90. At this point, shares remain under accumulation ahead of earnings. Quarterly profit is expected to come in at $0.28 a share, up 155% from a year earlier, with sales seen up 28% to $1.05 billion.

Lennar (LEN) -- Weekly
Source: StockCharts.com

A common pitfall for investors is to chase performance, but buying too late is an easy way to lose money. At this point, it would be better to wait for builders to pause and consolidate gains. The strongest performers in the group, like Ryland (RYL), D.R. Horton (DHI) and PulteGroup (PHM), could all come down to their respective 10-week moving averages and find support. If they do, it will be a viable area to start a small position. The other scenario is that they'll start moving sideways, holding gains in light volume. Price action like this is good to see after a breakout, as it's a sign of support.

On Friday, KB Home (KBH) had more good news for the homebuilding sector after the company reported solid earnings. The Thomson Reuters consensus estimate called for a loss of $0.16 a share, but KB Home turned a profit of $0.04. Sales rose 16% from a year earlier to $424.5 million, a little below the consensus estimate of $430 million.

The company delivered 1,720 homes in the quarter, up 7% year over year. The average selling price rose 8% to $245,100. KB Home also said its backlog rose to $744.7 million in the quarter, up 33% from the prior year.

I don't consider KB Home the leader in the group, even though several above-average volume gains point toward institutional buying as well. The stock recently broke out above $10.76, its intraday high, set on July 10. On Friday, shares soared 16.4% to $15.26. Its recent high of $13.12 was taken out with conviction.

KB Homes (KBH) -- Weekly
Source: StockCharts.com

Meanwhile, the iShares Dow Jones U.S. Home Construction Index Fund (ITB) continues to perform well, but it's extended in price after a late-June technical breakout above $16.30. Shares closed Friday at $20.57, up 1.9%.

While the headlines remain mostly positive in the homebuilding sector, there's no need to chase here. If the market pulls back constructively in coming weeks, the home builders will pause along with it. New bases will form. When the builders digest recent gains, this is where new entry points will most likely be seen.

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