I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Sunday, October 25, 2009

Homebuilders, Making a Few Distinctions: A Technical Appendix to FB's Newest Post

For those of you who don't know who floridabuilder is, he has been a dominant Caps player for years, but most importantly his blog posts on the home building industry are the stuff of legend (well, I don't know if they can technically be called a "legend" since you can go back a re-read all of them, but let's just say they are legendary and held in very high esteem by many :) ) He was one of my earliest favorites in my binv271828 portfolio.

As the title of this post says, it is an appendix to FB's post: Break Time - NVR - If your going to be a bear, try not to look like a jacka$$. It is a fantastic read, and a prerequisite to understanding this post

First, let me say I am a bear (My friend Mark910 sums up my thoughts pretty well My name is Mark and I am a Bear......My 12 step recovery plan.). But let me add more nuance to this statement. Like I say at the top of my blog - "I analyze macroeconomic issues from a fundamental and technical perspective". So when I look at the long term fundamentals and technicals, from a macroeconomic perspective, I am bearish on US equities as a general asset class for the next 5-10 years (which means that I think equities will have nominal losses, but more importantly hugely underperform other asset classes). Here is my spiel as to why I think this: binve's long term view. But I am not a bear for the sake of being a bear, I would much rather be long US equities and I think over the long term, after we complete a needed correction, US equities will be another huge true bull market. Please read the comments in blue at the end of this post: Thoughts on the Dow/Gold Ratio

And notice my wording --- I am bearish on US equities as a general asset class. This is the main reason why I focus on the broad market indicies (SPX, INDU, RUT, COMPQ, and NDX) when I do most of my analysis. Because this is the best representation of how the market interprets the broader economy. But that's the thing about general asset classes, you can apply your analysis to them only generally. Some will outperform the average while some will underperform the average.

And so lets get into homebuilders. I too am bearish on homebuilders as a sector for the long term, but there will be outperformers and underperformers here too.

Which goes exactly to FB's point, the importance of being able to make distinctions. Here is an excerpt from his post:

"... What cheeses me off to know end are people that can't make distinctions

Everything sucks, there are no jobs, all real estate is worthless, blah blah blah..............

You know why? Because they are masters of the obvious. Look at my distinction tree, no pun intended. The more distinctions you can make on any subject in the world the more wealth you will make within the boundaries of that subject. Who makes more money? A professional cook that is highly trained in French cuisine, with an unmatched pedigree who lives and breathes his subject matter? Or the CPA MBA who gets bored with numbers, because it is all the same day after day crunching numbers............ Who is paid more money? Who is more sought after?

It doesn't matter what your field of expertise is, except for this, the more of a subject matter expert you are the more money you make and the more you will be taken seriously. Seriously.

You become rich by understanding distinctions that other people can't see. You become rich by investing your time (your job and investments) in those areas. Life really is that easy. ..."

And this is an exceptionally good and valid point. FB has proven his ability to consistently find outperformers and underperformers in the Homebuilding sector. His analysis of these companies and how the supporting industries (mainly financials) affect HB performance is unmatched.

So, normally if I looked at a sector, as a macro guy, I would look at the average sector behavior (through a good index / benchmark) both fundamentally and technically. But for this post, I am going to look at some individual issues and see if there is some wheat that is separable from the chaff. And of course, there is. Not because of anything that I will show you, but because FB had done all the fundamental analysis and has shown us this is the case.

Let's look at some charts.

We will be looking at NVR, SPF, XHB (for an index comparison), and a random assortment of other tickers. No need to provide fundamental analysis, FB has already done all the work:

- Break Time - NVR - If your going to be a bear, try not to look like a jacka$$
- Chapter 3: Builders - did land prices double? why this is bad for banks... real bad.
- Chapter 2: Builders - The $8,000 Tax Credit Question + Did Land Prices Just Double?
- My best blog ever! Seriously.. Geitner plan, a smattering of poop, and who really controls the US
- Pitch thread for NVR
- Pitch thread for SPF

These are just a few resources provided by him.

Before jumping into the individual charts, lets see what the chart of XHB (homebuilders index) looks like:

Yep, as expected we have had a large move down from the top. Moreover, the move down is very impulsive (5 waves). And since a correction is *never* a Five by itself, a Five is only part of a correction. This is an important fact, and it will show up in more analysis and charts later on. So regardless of the current rally, the long term forecast for builders is down, per this wavecount analysis.

Another note, the XHB index was established in early 2006. The reason why we call the 2006 peak as a "top" (rather than it just being a local high point on the chart due to a not-very-long price history) is that most of the builders show a peak that occurs right at the identified peak, early 2006.

As per the original post referenced above, FB has maintained the NVR is the outperformer in the group, so lets take a look at NVR from a long term perspective:

This is a very healthy chart. A nice clear impulse up since 1995. Moving up steadily through the tech boom and the early 2000 sell-off.

As I was saying above, the general description/analysis of a sector applies to that sector generally, and there will be both out and under performers. NVR is the clear outperformer. FB has identified the the fundamentals behind the strength, and the technicals are confirming it.

And while the long term chart of XHB forecasts long term weakness, the long term chart of NVR forecasts long term strength.

So let's zoom in to a shorter timeframe.

NVR has been correcting with the rest of the homebuilders since the peak in 2006. This was a sea-change in builder stocks coinciding with the real estate market peak. Even the strongest builder cannot escape from this unscathed.

But if we examine the structure of the correction, it is clearly *NOT* impulsive down. By my count, it looks like we are getting a double-three (regular flat followed by an expanded flat -- my projection). I think NVR will have one more correction when the rest of the market goes through its next large correction (I think there will be another large down move in stocks next year, which I know that most do not agree with me on this). But beyond that, I think NVR will bottom faster, and be making new all time highs while the rest of the homebuilding pack (as measured by the XHB) is still languishing.

But lets stop talking generals with XHB, lets look at another builder specifically: SPF.

SPF is a horrible builder. I have looked at their balance sheet, and it makes me want to vomit. I normally do not short stocks outright, but I shorted SPF in real life in 2007-2008 a couple of times very profitably. Unsurprisingly, FB is bearish on SPF as well. Lets see what the charts have to say about SPF:

The count for SPF is nearly the same as XHB, since the peak in 2006 the count is a very clear 5-waves down. This large impulse means SPF's woes are not over yet. But I am also showing a projection that takes SPF higher (in a relative sense) before it starts it's next large downleg. (see the notes on the chart)

Let's think about why for a second:

From the peak, SPF was down > 98% !!. So in order to put in a decent rally off the bottom, very little interest is needed. It was just so utterly oversold, and the bullish sentiment for SPF was utterly spent, that short covering and a little speculation can drive a nice bounce.

Maybe you disagree and think that SPF has turned the corner and is now a healthy company and that is the reason why they are trading higher. If that is your theory, good luck with all that. To me, the chart says maybe some more upside for the next few months, but lots more downside (maybe even de-listing and/or bankruptcy) for the long term.

Now lets compare NVR to SPF side-by-side:

Read the notes on the chart. This goes to the observation that I made earlier: And since a correction is *never* a Five by itself, a Five is only part of a correction.. The is the main reason why the NVR chart looks long term healthy while SPF does not. The NVR correction counts as a healthy correction with a healthy retracement level, corresponding to a well-run company positioned well in its industry. SPF ... not so much.

Next lets look at some comparison among a few HBs:

These are a lot of the big names, and what is immediately obvious is that most have patterns that look like XHB. Large impulsive move down. NVR is a clear winner here. And based on my TA above, will continue to be for a long time.

Finally, lets compare against the market and the Lumber index

So FB knows what he is talking about when it comes to red thumbing and green thumbing builders. However, this is exceptionally obvious and a large post from binve filled with charts is unnecessary to make or confirm that point.

But what I liked about going through this exercise was that the the fundamentals of the industry and several prominent names in the industry, as identified by FB, is confirmed by TA. Most of you hate / don't believe in TA (and most despise Elliott Wave even more), so I am not expecting this post to make anybody a convert.

In short, it was useful for myself and I am sharing it with the community. Hopefully it was useful to some of the rest of you as well.

Addition 6:05 pm

Long term sector performance and peaks

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