Housing Trade Update

By Dr. Duru written for One-Twenty

May 23, 2007


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The drama in the housing market seems to continue to play out in slow motion. While just about everyone has finally admitted that the housing industry is in the middle of a post-boom recession, even a busted bubble, the debate continues on how much worse the decline will get and whether this decline will take the rest of the economy with it. The current strong rally in the stock market indicates that traders and investors have chosen to ignore the woes of the housing market. And, in turn, this market rally is helping to keep a lot of housing-related stocks on life support. Where such benign neglect occurs, you find peril or opportunity. For the past two months, I have been focused on the opportunity - and almost 3 months since I officially called the housing stocks "broken."

I have focused on three potential sources of opportunity: 1) playing bounces from "oversold" conditions at or near technical support levels, 2) buying following vigorous selling on bad news, and 3) looking for working theses that can come to fruition over a longer timespan. Of course these conditions are not unique to the housing stocks. But these points of opportunity can turn in large returns in an overall negative environment like the one the housing stocks live in. More importantly, I believe that I have spent enough time watching (and talking about!) these housing-related stocks that I can feel particularly comfortable interpreting the potential for unique opportunities. I will now summarize where things stand today relative to these opportunities (read disclaimer here):

  1. First note, that I have now sold out of almost all my housing-related plays. I got another round of nice profits, and I wanted to lock them in. The recent sharp rise in interest rates has me thinking that the downside risks have increased tremendously for housing-related stocks, and I want to have cash ready in case the market suddenly and abruptly wakes up to the implications of these higher rates to housing-related stocks.
  2. XHB - opportunity #1: this homebuilder-related ETF has become my favorite way to play the general volatility in housing-related stocks. I now very rarely play the individual stocks without a specific theme. This helps reduce the risk of getting blindsided by some unexpected bad news. On the other hand, it also eliminates extensive upside surprises. Anyway, XHB spiked strongly on Tuesday to match April's highs. Without any really strong housing-related news flows, stochastics reaching over-bought conditions, and a strong short-term rise in rates, I thought it best to lock in the profits for now.
  3. Beazer Homes (BZH) - opportunity #2 and #3: The stock reported earnings on April 26, revealed another lawsuit claiming mortgage fraud, and still the stock spiked 5%. Based on that surprising strength, I put the stock back on the watch list. Faithful readers know that I was buying BZH as a "despair trade" when it collapsed on the news of the first lawsuit and sold out in the middle of the post-panic bounce. This time, I bought twice as the stock trickled down the declining 50 DMA. The second purchase was much better as I also got oversold stochastics and convergence with the lower BB. BZH finally bounced from there, and I sold for a decent profit in the ensuing bounce. (And like the previous round, I sold a day before the largest spike of the move!). BZH remains on my watchlist, and I am particularly looking for updates on the lawsuits regarding alleged mortgage fraud.
  4. Indymac Bancorp (IMB) - opportunity #3. IMB is a permanent fixture on my watchlist. I earlier talked about the encouraging buying by insiders. The volatility in the sotck has surprisingly given me several consistent opportunities to buy dips and sell on bounces. The most recent spike was the most profitable of all. IMB moved on news that iStar Financial bought the commercial real estate business of Fremont General (FMT). iStar is even retaining a financial interest in FMT's assets. This is yet more evidence that value remains in the mortgage-industry. Liquid cash flows continue to move to buttress this critical component of the housing industry. While stocks like FMT, LEND, NFI, and IMH provide a lot of upside bang (good for playing in virtual stock trading contests like CNBC and TheStreet.com), I prefer to stick mainly with IMB because the insider buying gives me more confidence that downside risks are minimal. The short-term trend since the bottom in March remains up, so I am a buyer on dips. But serious resistance looms overhead from the declining 200DMA, so I remain a seller on spikes until we conquer that level.
  5. Wci Communities (WCI) - opportunity #3: WCI is an open housing play. Billionaire big-man Carl Icahn offered $22/share to buy WCI, and the current board wasn't having it. As time ticked away toward the expiration of the tender offer, the stocked slipped away. At the lowest point, the stock was actualy selling at near a 10% discount to the offer. I bought a bunch of shares right after the tender offer expired unfulfilled. I figure WCI will fetch at least $22, and if the baord thinks it can get more, then I have the potential for even more than a 10% gain. I am a buyer on dips.
  6. Building Material Holdings (BLG) - opportunity #3: BLG remains an open housing play. The timespan on this one does not expire until the middle of the summer or so. The stock has continued to sell-off, and I continue to nibble in small chunks. The stock has bounced in the past few days, but I doubt the move will sustain given the on-going persistent downtrend. I realize I am going against many common technical wisdoms here, but I remain convinced of the the potential upside over the next several months. See my earlier post to understand my madness on this one!
Overall, short interest remains extremely high on the homebuilders and other housing-related stocks. Until the economy shows additional signs of weakness and/or the market finally decides to correct again, I strongly suspect that these shorts will continue to get squeezed. I will remain a purveyor of opportunity instead of doom until "something" changes to change my mind. Of course, if recent history is any indicator, the market should give the housing bears at least one more opportunity to growl another "I told you so" before the year ends.

In the meantime, be careful out there!

DR. DURU®, 2007