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July 23, 2005

Homebuilders Are About to BARF
by Dan Basch

Introduction: The Housing Party's Over

When a stock looks toppy, a popular saying among traders is, "Stick a fork in it, it's done." In the case of today's wild bash mania housing sector a true contrarian would say, "It's so sloshed, it's gonna hurl." Crude though it may be, in the case of the Philadelphia Housing Sector Index (HGX) the metaphor fits. Allow me to explain using technical analysis how this index may soon be overtaken by waves of selling nausea, and this upcoming purge will likely mark the end of the housing boom.

Today's roaring housing sector is exemplified by the Philadelphia Housing Sector Index (HGX) and the technical chart formation that can be readily identified in at least two of its components is the Bump and Run Formation, also known by its abbreviation, BARF. At least this was its original acronym until its discoverer chickened out and renamed it BARR for Bump and Run Reversal. I like the concept of BARF because it so accurately describes market action after the development of this formation so, for the sake of base humor which serves to make this essay memorable and in the true spirit of its technical nature, I'll stick with this original designation.

I have identified textbook patterns of this formation within two of the components of the Philadelphia Housing Sector Index which indicate from technical analysis that they are about to blow chunks of market valuation. I'm sharing this with you now so you can consider avoiding getting stuck with the blotto crowd who've already done the stock market equivalent of keg stands and quarters and now staggers and slurs that oft uttered phrase of the college freshman at his first kegger just before chowdering, "Dude, I don't feel so good..."

The Consensus: Bitchin' Chart! Party On, Dude!

First, let's begin with an overview of the strategic picture, a weekly three year chart of the HGX itself. The first thing one may observe is that it has an amazing uptrend since early 2003 rising about 190%, thus fitting the necessary criteria for a BARF which only occurs when excessive speculation drives prices up too far, too fast. It may even form a Rising Wedge which has a tendency to break downwards as may be inferred by the CCI and MACD indicators which are both showing negative divergences.

However this in and of itself doesn't meet any specific criteria for a BARF and therefore one would assume that from the looks of this chart that with such a powerful uptrend, someone would have to be nuts to be bearish here. Relax, dude, have another brewski and you buy the next round of housing stocks.

It is at times like this that one must remember the sobering concept that technical analysis is based upon the premise that looks can be deceiving.

The Setup: Homebuilders Chugged Capital Like Keystone at a Frat Party

I have selected two prime components of the HGX, Toll Brothers, Inc. (TOL) and KB Home (KBH), which have two things in common: 1) They are huge in the home building market (just these two comprise 13% of the total HGX) and, 2) Their stock charts meet every one of the several rigorous criteria for a Bump and Run Formation before the run and each appears to be topping.

In order to accomplish this, one needs the criteria in order to assess each stock's chart for potential as per the criteria for a BARF:

1) The lead-in phase lasts for several months meeting criteria of >1 month, lead-in trendlines are moderately steep.
2) The Bump forms a sharp advance diverging from the lead-in with the angle well exceeding the 50% greater requirement.
3) Bump validity is confirmed by the distance from the highest high of the bump to the lead-in trend line which is at least twice the distance from the highest high in the lead-in phase to the lead-in trend line.
4) Speculation should die down and a top forms.
5) Volume becomes average or decreases during the lead-in phase and increases in the bump phase.
6) Run phase pending...
7) Trendlines have yet to be tested...

Rush Week For Tau Omega Lambda and Kappa Beta Eta

The first frat in the Greek order of homebuilders is Toll Brothers, Inc. (TOL). As you can see TOL has imbibed huge amounts of capital and thus is high in a stock stupor. This stock is plowed on huge amounts of speculative capital and it meets every one of the above criteria for a BARF. It appears to be topping and just about ready to run.

The second stock from the brothers of KB Home (KBH) has certainly impressed the chicks with winning the massive capital chugging contest, but after meeting each of the above criteria, this stock appears ready to grab the rim and hurl as the next phase of the BARF will likely make it run:

Conclusion

Like college partiers who overdo it, the Philadelphia Housing Sector Index has become intoxicated in an outright housing market mania which is just starting to get the spins. It's time to reconsider positions in the homebuilders before they collectively stumble for the can and toss the excess speculative cash they've imbibed. The best they can hope for is a friend to hold their hair back.

Keep in mind that this is occurring within the context of other potentially bearish developments in various indices that forebode of a potential general market decline. A large part of the overall stock market's recovery since 2002 has been aided by the housing sector, and as the BARFs on the above housing stocks indicate, the party's almost over. The coming decline in housing stocks could quickly gain momentum and spread to mortgage lending and housing materials companies that could lead to an all out rout.

Since I am not a professional investment advisor, and am merely a garden variety retail speculator and I'm absolutely not qualified to give investment advice of any kind, my non-advice would be to brace yourself, for the technical formations on some of the most significant components of the Philadelphia Housing Index indicate that housing stocks are topping which signals the end of the housing bubble is nigh.

And just like with the day after an alcohol binge, dude, this hangover will be gnarly.

Dan Basch