Homebuilders: Too Hot To Handle

With stocks like D.R. Horton Inc. (NYSE: DHI), Lennar Corporation (NYSE: LEN) and KB Home (NYSE: KBH) closing higher for a fifth day in a row, it is little surprise that exchange-traded funds representing these stocks are climbing into overbought territory.

But the fact that these gains in funds like the SPDR Homebuilders ETF (NYSE: XHB) and the iShares Dow Jones U.S. Home Construction Index Fund ETF (NYSE: ITB) are coming as the ETF trade in bear market territory means that traders and active investors in these funds should be prepared for the potential of lower prices in the near term.

Why so?

Up four days in a row, shares of XHB have finished in overbought territory for each one of the last four closes. Over the past two sessions, XHB has closed with a 2-period RSI of more than 95 – extreme levels by any estimate. The ETF has also earned a negative edge of more than 1% heading into trading on Friday.

Also with a negative edge of more than 1% ahead of Friday’s open are shares of the iShares Dow Jones U.S. Home Construction Index Fund ETF. ITB has finished up for the past five days in a row, but has only arrived in overbought territory over the past two sessions (compared to XHB, which has closed overbought every day this week).

Both XHB and ITB are rallying toward levels where, historically speaking, sellers have tended to overwhelm buyers. Bear market rallies as recent as late October and as far back as late August – as well as every significant rally in between – have been sold as the funds climbed deeper and deeper into overbought territory. Shares of XHB dropped for four straight sessions after a rally into overbought territory near the end of August, losing more than 7%. Rallies to overbought levels in late October and November in ITB led to three-day sell-offs in two out of three occasions.

The ProShares UltraShort Real Estate ETF (NYSE: SRS) provides traders with a slightly different exposure to the real estate market – focusing less on homebuilders and more on real estate investment trusts like Simon Property Group (NYSE: SPG) and Boston Properties (NYSE: BXP). The fund began trading on Thursday down three out of four, and was up 2% on the day. That said, SRS still has a positive edge in the short term and could see addtional upside before becoming overbought enough to attract significant selling.

All of the ETFs in today’s report were available from research and data available through The Machine. To learn more, click here.

David Penn is Editor in Chief of TradingMarkets.com