HOME BUILDERS STOCKS ARE ON THE MOVE

As the ice begins to break up, investors may be tempted to dip a toe into the frigid sector - just to test if the worst is over and there is finally profit to be made again. In this article we'll explore signals that capitulation is in full swing and examine if now is the time for contrarian investors to dive in.

Since the low in the fourth trading week of January, the Dow Jones U.S. Home Construction Index (DJUSHB) rallied 40%, as of the close on Thursday. Technical analysts know the recent pop means descending resistance of the relevant downtrend has been breached. However, technicals are lagging indicators and are simply a visual map of market action, based on underlying fundamentals. While the chart of the DJUSHB shows a breach of the relevant downtrend, what's really happening is a fundamentals-related shift within the sector.

It's Darkest Before the Dawn
Last Thursday, the Associated Press reported that existing home sales fell by 13% for the year, according to the National Association of Realtors. Talk about dismal. If that‘s not enough, total U.S. median home prices dropped on an annual basis for the first time since the 1968.

Here's the rub, when there's no end in sight and the whole market starts abandoning the sector, it's usually the time to start buying. Then again, those who've been on board with homebuilder stocks over the past few days already know this.

Stimulus Plan Good For Homebuilders Too
President Bush is attempting to implement an economic stimulus plan in which subprime mortgage rates will be frozen for five years. What this means is that those who are in way over their heads can relax a little…at least for a moment. At the end of the day, the government is doing everything possible to dig out subprime borrowers. And housing stocks are benefiting…at least the ones with solid fundamentals.

There was a rumor that Warren Buffett was thinking about buying Pulte Homes (NYSE:PHM), though not much has surfaced in the way of real news. However, the company is trading with an ungodly low price-to-sales of about 0.30 and a laughingly cheap price-to-book of 0.65. The fact is, the company has taken so many charges over the past year that its freefall has driven the stock into fundamental attractiveness.

What's vital to know right now, though, is that even though the company looks quite appetizing at current levels, there really isn't any evidence that consumers are sure to begin borrowing again. It's hard not to think that new homeowners won't resurface, especially with the recent economic stimulus freezing ARMs, providing tax rebates…and of course the Fed's recent rate cut. But the market is good a bucking trends, and therefore if a total rebound is expected too early in the game, investors could find themselves pounded again.

The Bottom Line
What it comes down to is common sense. While fundamentals of several homebuilders, including Ryland Homes (NYSE:RYL) and Tol Brothers (NYSE:TOL) seem enticing, those seeking to establish positions based on the recent turnaround may want to ease in ever so slightly, because we may end up finding these homebuilders' foundations to be in even worse shape than expected.