I’m shorting home construction stocks — here’s 3 reasons why

The broad market spent the session
trading in a narrow, sideways range, but each
of the major indices closed marginally higher and built on their gains of the
previous day. Each of the major indices opened slightly lower yesterday, but
grinded higher and finished near their best levels of the session. The Dow Jones
Industrial Average
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higher. Both the S&P 400 Midcap
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indices closed 0.4% higher as well. The S&P 500
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each gained 0.2%.

Volume continued to return to the markets as the annual
“summer doldrums” come to an end. Turnover in the NYSE rose by 8% yesterday,
while total volume in the Nasdaq increased by 6% over the previous day’s level.
As the S&P and Nasdaq each closed higher yesterday, both indices scored another
“accumulation day.” It was the second consecutive day of institutional buying,
but remember that the broad market has had at least four bearish “distribution
days” within the past four weeks as well. Market internals were mixed throughout
the day, but closed positive. In both exchanges, advancing volume exceeded
declining volume by a margin of 1.6 to 1.

Relative weakness in heavily weighted stock Genentech
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caused the Biotech HOLDR
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yesterday. However, our trailing stop strategy nevertheless enabled us to lock
in a gain of 3.38 points on the BBH position. The Semiconductor HOLDR
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which we targeted for long entry yesterday, failed to exceed the September 6
high and therefore has not yet broken out of its sideways consolidation. We
continue to stalk SMH for possible long entry today, but only if it clearly
trades above Tuesday’s high. The 20-day moving average again acted as support on
SMH yesterday morning.

One sector we want to bring your attention to is the DJ Home
Construction Index ($DJUSHB). Last month, after many broke below their 50-day
moving averages, we pointed out the bearish reversal and relative weakness in
the home construction stocks. Since the beginning of September, the index has
retraced a little more than a third of the previous month’s losses, but many
home construction stocks are now coming into resistance of their downtrend lines
and 50-day moving averages. The $DJUSHB index, for example, closed just shy of
its downtrend line from the July 29 high and also has resistance of its 50-day
MA just overhead:

The resistance shown on the chart above indicates that many
stocks within the home construction index are again presenting ideal entry
points for new short positions. Further, a miss in the quarterly earnings of
Hovnanian
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sector to trade sharply lower after hours. While we never trade stocks purely
because of news, we have found that negative news often coincides with pivotal
areas of support or resistance. In this case, the HOV earnings report, combined
with the downtrend line and 50-day MA of the $DJUSHB index, should cause the
home construction stocks to resume their downtrends. As you probably know, there
is not an ETF that directly tracks the home construction stocks, but you can
make your own “synthetic ETF” by shorting a small basket of stocks within the
sector. For example, instead of shorting 600 shares of one home construction
stock, consider shorting 200 shares of three different ones. Doing so reduces
your risk by giving you the same benefit of diversification that ETFs offer.

Because the Real Estate Index Trusts (REITs) often move in
sync with the home construction stocks, you may want to keep an eye on both the
IYR and ICF exchange traded funds. Although we stopped out of ICF a few days
ago, its bearish head and shoulder pattern is still intact. A drop below its
50-day moving average would be sufficient reason for us to re-short it. As
always, we will send an intraday e-mail alert to regular subscribers if/when we
short ICF (or IYR).

As for the major indices, yesterday’s action did little to
change the technical picture on the daily and weekly charts. The 0.4% gain in
the Dow Jones Industrial Average caused the index to close right at resistance
of its weekly downtrend line that began with the March high (as illustrated in
yesterday’s Wagner Daily). While the downtrend line could prove difficult
for the Dow to immediately overcome, the blue chip index has suddenly been
showing clear relative strength during the past two days. As such, shorting DIA
strictly because of the downtrend line is probably not a good idea. Both the S&P
and Nasdaq are moving closer to their 52-week highs, but it is wise to maintain
tight stops on long positions until the indices prove they will not set lower
highs. Given the advance of the past two days, there is a good chance the broad
market will pause to catch its breath today. But if it does not, we can
interpret the recent market action of the bullish reversal to be quite positive.

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