With bad news from Lennar yesterday, home builder stocks did the opposite of what they should have done and rallied up yesterday.

In fact, one home builder's stock (Hovnanian), has rallied up 22.9% in the last 14 days.

Contrarians are said to be buying home builder stocks. Is this the case, or were home builder stocks oversold and affected by the huge amount of investors who have shorted these stocks?

In Hovnanian's case, nearly 25% of there stock has been shorted and that amount would take about 7 days of trading volume to cover.

This opens the possibility for a continued "short covering" rally. In short covering rallies, as the price of the stock moves up, those who are short start losing money. As the pain gets to great, they close their short positions.

The only way to close a short position, is to buy the stock on an up tick, which drives the price even higher. This goes on until there are no more buyers, and no more shorts that want to cover ... and then the stock has a correction.

In Hovnanian's case, the stock's price chart shows 2 unfilled gaps on the upside. See below.

The lower gap will probably be filled today, and the question will be whether or not the second one gets filled. If it does, then Hovnanian will have one spectacular upside move.

On the other hand, if the buying were to stop tomorrow, investors would face some sharp loses. This is a high-risk speculative condition.

The question many are pondering is ... Is this really the beginning of a contrarian's trend to the upside for housing stocks? ...

To answer the question, let's look at what the financial news being reported on the corporate side, and then look at the actual Housing Data.

Stuart Miller, CEO of Lennar, said the following yesterday:

- Cancellations in gross orders increased 30 percent from the year-ago period.

- We haven't seen the bottom of the housing drop yet.

- Lennar reported a 39 percent decrease in earnings from continuing operations and a 31 percent rise in costs of homes sold, land sold and general and administrative expenses.

- Gross margins on home sales were 18.7 percent, down sharply from the 26.3 percent last year.

- Customers in backlog are also demanding concessions or are walking from deposits.

Two other large homebuilders, Beazer Homes USA Inc. and KB Home, cut their full-year financial forecasts this month.

Pentair Inc., the water filtration giant, cut its third- and fourth-quarter earnings outlook. The company also announced up coming layoffs and a $17 million charge in the third quarter to cover severance costs and increase warranty and inventory reserves. (Pentair's third-quarter 2006 estimate will drop to 30 to 32 cents a share, down from the previous estimate of 46 to 50 cents a share. Fourth-quarter earnings are now expected to be 33 to 35 cents a share, down from the previous forecast of 53 to 59 cents a share.) Pentair blamed the trouble on the nationwide housing slowdown. Pentair's stock closed at $26.13, down 10 percent.

Home improvement company, Lowe's, warned that its full-year 2006 profits would be at or near the low end of its previous forecast and it expects AND that it could take as long as 12 to 18 months for the slowdown in the housing market to stabilize.

What does the Housing Data say about what is going on?

Last night, I went through the Government's U.S. stats on new Housing Permits for Single Family Homes and created the chart below in order for you to see the big picture.

Permits for new homes trended up for 45 months, from January 2002 to September 2005 when they hit a peak.

And then, in the last 11 months, the drop in new permits fell precipitously back to the January 2002 level as seen below.

Lowe's may be right when they say that it could take as long as 12 to 18 months for the slowdown in the housing market to stabilize.

For now, what we do know, is that Housing will not bottom out until Single Family Housing Permits stop falling and reverse back up. The "hard landing" for housing everyone is worried about will remain a possibility as long as Permits continue to decline and home builders face cancellations of previous sales.

What about falling mortgage rates, will that turn things around?

It may, but the question is when, and if it will. If it does, investors will know because they will see the drop in Housing Permits bottom out. So far, there is no sign of that as seen on the chart below.

If anything, lower mortgage rates could start a rush by many to refinance. That would be a very good thing for consumers, because many are caught in ARMs that will soon have substantial increases that would be damaging to both consumer spending and the economy.

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