The housing slump continues

A double dip in housing? Well, it’s starting to appear so. Two housing reports released this week seem to paint a gloomy picture for the housing market. As reported on Tuesday, existing home sales fell 2.2% to a much lower-than-expected annual sales rate of 5.66 million. To make things worse, yesterday’s new home sales report fell 32.7 % to an adjusted annual rate of 300,000. For the housing optimists, the scary part about the latter report was that it hit an all-time low. Although the decline in May was anticipated (thanks to the tax credit that expired in April), most analysts did not expect a drop of this proportion. It would appear that many banks are starting to place more foreclosed properties on to the market, possibly causing more downside pressure to an already weak housing market.  Even though analysts had been expecting better of these two reports, is it possible that the markets were not?

Below is a 1 Yr. chart of the XHB, which is the SPDR Homebuilders ETF. This ETF is a way for investors to invest in the housing sector, somewhat similar to a mutual fund. Specifically, this ETF is a collective investment in industries, such as homebuilding, building products, home furnishings, home furnishing retail and home improvement retail. This ETF is also a great way to gauge the market’s “thoughts” on the housing market. In other words, if the market was expecting housing o improve, wouldn’t the XHB reflect that expectation with a trend toward higher prices? Please take a minute to analyze the chart with the notes I have made.

XHB – 1YR

The first thing you might notice is the trend lower over the last two months. Always remember that the markets tend to be forward looking. If money managers and advisors believe that  the housing market is going to turn back down in the future, are they going to wait until it actually happens to position themselves? Of course not. Think of it this way: When you’re driving down the road in your car, do you wait until it’s pitch black outside to turn your hedalights on or do you turn them on before it gets dark? So, it would appear that the XHB has been reflecting the belief in a downturn in housing, thus the recent downtrend.  The market simly believed that there was a problem in housing before the actual numbers got worse.

Now, were there other signs of potential problems ahead? Notice the break of the uptrending support line (blue) in June. The break of that 7 month trendline was pointing to probable lower numbers in housing and in turn lower prices ahead for the XHB. Lastly, the XHB has also been respecting a clear downtrending resistance (red) since it’s recent high of $20. By the same token that the break of the recent support line might foretell lower prices, might a break up through the current resistance point to higher prices for the XHB and an possible upturn in the housing market?

So, how might one make trades based on the information we see above? Here are some of the questions I’d be asking:

1)   Is it best to be short XHB or individual homebuilders?

2)   When might it be time to look to enter long positions?

The Tale of the Tape: The XHB has broken down, which points to lower prices. The highest probability trades would be short in either the XHB or individual homebuilder stocks such as TOL, LEN, KBH or others. You could also look to short housing retailers such as TSCO. If you look to short the XHB for a more conservative trade, the best entry for that trade might be on a retest of the down trending resistance (red) with a stop above that line.  If we break above that resistance, you could then start looking for long positions in the same stocks!

Waiting for the most opportune times that I have outlined above could provide you with the highest probability trading points. No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.

Good luck!

Christian Tharp, CMT