ETF Update: Surprising Strength in Homebuilders

The homebuilders present a conundrum.  Those who have learned to respect the market are taking note of the strength in this sector.  Those who focus on fundamentals are watching with amazement.

The human debate is mirrored by the different conclusions of our trading models, Oscar and Felix.

Background

Traders all seek rewards but they
have differing appetites for risk.  It is important to find a method
that suits your personality and needs.  Our trading systems are
basically Trend-following, but also include recognition of Cycles and a
touch of Anticipation.  Since we apply the method to ETFs, we call it the TCA-ETF system.  We follow two versions of this method, designed for
two clients with different needs and risk appetite.  [New readers can find more information about the models at the end of this article.]

Let me discuss this week's featured sector before turning to our own ratings.

Spotlight on the Homebuilders

We trade homebuilders via the SPDR S&P Homebuilders ETF (XHB).  The ETF has good diversification, with about 5% holdings in each position.  It trades at a P/E ratio of about 22 and a price-to-book of over 2.  The dividend yield is only 0.67% and the estimated EPS growth is about 13.5% — at least officially.  Given the price, someone must be expecting better news for these stocks.  Here is the chart.

This is the #1 pick for Oscar.  The more cautious Felix has assigned the sector to the Penalty Box (meaning that it is not a good candidate for prediction).

Fundamental Analysis

Those who are closely watching housing – -and who isn't? — are well aware that government support is coming to an end.  The Fed stopped direct investment in mortgages a month ago.  The $8000 credit for buyers ended last week.  If the market is forward-looking, why is the sector doing so well?

The problem is carefully described at Calculated Risk in a number of fine articles:

• Home ownership is down to 67% from a high of over 69%.  CR sees a little more decline to the 66-67% range.
• Home prices are declining and have further to fall.
• 96.5% of mortgages are backed by the government.  This nice chart from the San Francisco Fed via CR shows the dramatic change in the various sources of mortgages.

CR concludes that we are far from normal in housing.

Some attribute the sector strength to better new home sales in March, but this seems like a reach.

Other ETF Experts

We always monitor the conclusions of other ETF experts when considering a trading position.  This week there are several interesting comments from our favorite sources.

Maoxian proclaims complete ignorance of any fundamentals about the sector, but is up 24% on the trade for subscribers.

ETFdb notes the undeniable surge in the stocks at the time new home sales for March were announced.

ETF Daily News also emphasizes the technical indicators.

Tom Lydon recognizes both the strength and the conundrum.

Dr. Duru sees a potential short setup.

There is plenty of debate among leading experts.

A Possible Explanation

There is the hint of an explanation in the XHB holdings.  Only 30% of the stocks are homebuilders.  30% are construction materials and 30% in home furnishings.  Another 10% represent miscellaneous related stocks.  There is some activity in refurbishing homes and a rebound in consumer spending, so stocks like Home Depot (HD) and Williams Sonoma (WSM) have shown strength.  Just a thought…..

Weekly TCA-ETF Rankings

We are currently fully invested in our ETF
programs,  after holding partial positions all week.  We are happy to report and discuss performance with
interested investors.  We also offer a report on how we use the models,
and a free weekly email update. 
(Write to etf at newarc dot com).  Our actual trading is a
combination of both models and some weekly timing.

For the moment we are publishing the ratings list as of
Thursday's close in our weekend update, a one-day delay.  We are not
recommending these sectors, since investor needs and risk tolerance
varies.  We hope everyone finds the ratings to be a useful supplement to
their own work.

Here are the current rankings for
both Oscar and Felix.

Note for New Readers

Our weekly ETF Update is designed to assist both investors and
traders interested in ETF's and Sector Rotation.  We also have free reports, available
upon request to etf at newarc dot com.  These reports describe how we
use the system, compare results from Oscar and Felix, and contrast the
method with our long-term trading approach.

Our Method.  In this past article, we described our basic methodology
and why we believe the rankings are useful for fundamental traders and
technical traders alike.  While we urge readers to check out the entire
article, the key point is that ETF's pose challenges and opportunities
different from investment in individual stocks.  The fundamentals may be
more difficult to assess.  Even with a good grasp on fundamental
trends, there is a lot of technically-based trading in ETF's.  This
means that those trading with a fundamental approach (and we
do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system
synopsis. We look at Trending sectors, Cyclical Sectors, and build
in an element of Anticipation for both entry and exit — thus the name
of the model, TCA-ETF.  While we do not reveal the exact methodology for
spotting trends and cycles, the system is not a "black box."  The basic
elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box
trading.

We report the rankings each week, now on the
weekend with a one-day delay, using the Thursday output from the model. 
We monitor and trade this daily, and offer a free report (request via
the email address on the top left of the site) for those interested in
our weekly trading program.

Oscar and Felix. We follow two versions of this method, designed for
two clients with different needs.

• Oscar believes in the long-term strength of the economy and the
  stock market.  He has a lovable and irrepressible enthusiasm.  When
  things go wrong, he steps back for a bit, but soon tries again.  He
  expects to do better than others during good times.  Oscar understands
  that this approach involves more risk.  Oscar is opportunistic.

• Felix also has a positive long-term outlook, but he is something of a
  fussbudget.  He is much more cautious, with an emphasis on capital
  preservation.  He is perfectly willing to step aside from the market
  when there are signs of danger.  He knows that he will miss some moves,
  but that is OK.  He scores big gains when the market moves lower and he
  escapes the loss.

There is more detail on Oscar and Felix in this article.  There is more about the Penalty Box here.

Bonus Coverage

Vince did
some interesting testing.  He checked out his findings using groups of
stocks and time periods totally unrelated to the development of the
model.  This is a very professional approach — and a very unusual one.

He
tells me that we can expect Felix to provide excellent ratings for
individual stocks — not just sectors.  We have decided to share the top
pick in the Dow and the top pick in the NASDAQ 100.  These are
three-week forecasts.  For the moment I am not going to do any further
analysis, but I will post the top pick each week.  At some point I will
do a recap.

DJIA:  Chevron (CVX) is the current pick.  Boeing (BA) was virtually unchanged after two weeks, despite good earnings.  23 DJIA stocks
are in the PB.

NASDAQ 100:  Dell Computer (DELL) is the top choice.  eBay (EBAY)  was down almost 10% since our last update, two weeks ago, including a disappointing earnings report.  90% of
the 100 are in the PB.