Homebuilder Shorts Run for Cover

By Dr. Duru written for One-Twenty

August 4, 2006

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Amazing. I could not have called this one any better. Well, even better would have been if I had managed to make some money on my claim that a relief rally was underway in the housing stocks!

Anyway, on Wednesday morning I noted that it sure seemed like shorts were getting over-aggressive on their bets against the homebuilders. My biggest clue was the interesting relative strength they showed on Tuesday even as the major market indices opened down and struggled until a closing rally trimmed the losses. Sometimes, the real story is told "under the covers" - that is, you have to check out the intra-day action to understand what is currently on the market's mind. On Wednesday, the housing stocks rested, but Thursday, the stocks rested no more and once again far out-paced the rest of the market. This time, most of the stocks I follow had tremendous moves of 4% and more on larger than average volume. This action represents a sure sign that shorts are trying to get out of the way. Perhaps they do not want to be around in case the Fed says something soothing to the housing stocks? I do not blame them! As I noted in the earlier missive, the short interest in many of these stocks seems extremely high for stocks that have sold off for over a year and seem to sport rock-bottom valuations!

I will have to trust you to take a look at the charts yourself. I only have time to provide a summary of the action comparing the short interest with the size and relative volume of the moves on Thursday. The short interest is a repeat from the last missive. The format is as follows: [stock name]: July's short ratio (May's short ratio if I recorded it back then); Thursday price move up - Thursday's ratio of volume to current average volume.
  1. BHS: 20.3% (n/a); 6.12% - 1.11
  2. BZH: 17.0% (20.30%); 3.95% - 1.07
  3. CTX: 8.6% ( 7.80%); 4.21% - 1.18
  4. DHI: 3.6% (n/a); 5.60% - 0.98
  5. HOV: 31.9% (14.80%); 4.76% - 1.28
  6. KBH: 11.1% ( 9.50%); 6.25% - 1.34
  7. LEN: 7.3% ( 7.70%); 4.46% - 1.26
  8. MDC: 14.8% (n/a); 3.40% - 0.80
  9. MHO: 17.6% (n/a); 4.35% - 0.63
  10. MTH: 18.1% (13.90%); 5.13% - 0.77
  11. PHM: 9.3% ( 7.60%); 5.41% - 1.29
  12. RYL: 13.7% (n/a); 4.55% - 1.52
  13. TOL: 12.1% (11.10%); 4.47% - 1.05
While there is not a consistent correlation between short-interest and the size of the price move or trading activity, you can see that almost across the board, the action was quite vigorous. For comparison, the S&P 500 was up only 0.13% for the day in what was choppy but lackluster trading.

On top of this action, we even had 8 of the 13 housing stocks listed above tap or even crash right through overhead resistance in the form of the 50DMA: RYL, KBH, BZH, NVR (not listed above), LEN (actually launched from its 50DMA!), TOL, CTX, HOV, PHM. Folks, this is all-around impressive action! Supporting this action is that the 10-year Treasury has incredibly dropped all the way down to a 4.95% yield! Clearly, the market has a short memory when it comes to the Fed's earlier jawboning trying to get these rates higher.

However, I am sorry to report that the trend in these long-suffering housing stocks remains decidedly down. Not only that, you can bet that a whole lot of traders are taking notice of the building rally (pun intended). This means, the market is even more likely to play some tricky games. The time to jump in at good or even low risk has past (right after I wrote Wednesday morning would have been a good time!). The shorts and buyers will now really be jostling for one-upmanship. The shorts will try to manage an orderly retreat, but I suspect it could get even uglier for them quicker than they can imagine, especially if the Fed manages to give the market cheer again. As you know, I do not trust post-Fed pops. In fact, I hate them. We would do well to get some fear back in the market with some selling going into the Fed statement and more selling right after. At least then we could get the buyers using the excuse that the negativity has gone too far. Better that than the sellers noting the euphoria has gone far enough! Anyway, I would go for those stocks that appeared to score highest across all the technicals I presented above: CTX, LEN, and KBH. (Please see disclaimer here.) All have very low valuations and even KBH now has a 2.4% yield, so you could even get some value players blowing wind into your sails.

Note well! I am not calling for a sustained bottom like I did earlier this year in February. This is strictly a very short-term trading call. I fully expect this rally to get faded at some point soon, especially since the first break of the 50DMA out of such ugliness rarely works the first time around (imminent Fed cheer not withstanding). Again, the best time to enter was when I first wrote about this move (isn't hindsight grand?). Anything is possible of course, but I wanted to warn against getting trigger happy here.

Be careful out there!

DrDuru, 2006