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The Battleground

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On Monday we touched upon the National Association of Realtors' report of existing home sales for February. That number was slightly below January's record rate, but strong nonetheless.

This morning, the Commerce Department reported the new home sales number for February. Sales rose by about 5 percent annually last month. The number of new homes sold, 882,000, pretty much matched the market's expectations, but was off of last year's record sales.

The month-to-month figures are volatile due to the nature of the reporting. The trend in sales is what economists typically monitor and give more credence to. The trend in housing remains very strong.

In essence, the two reports this week revealed that the market has eased from its record levels last year, but remains very strong in absolute units sold, both new and existing.

The fundamentals of the housing market lend a bullish bias to the housing stocks. But in the last two weeks, the housing stocks have not responded to the positive data. We're witnessing that pattern again today as the housing stocks under perform the broader market by a wide margin. The Dow Jones U.S. Home Construction Index ($DJUSHB) is lower by nearly 3 percent at the time of writing, while the Dow Jones Industrials ($INDU) were holding onto a 0.50 percent gain.

We've witnessed a significant increase in day-to-day volatility in the housing stocks in the last two weeks. The average daily swings in the $DJUSHB have increase to the point where the index now trades as if it's a member of technology; the emotions in the $DJUSHB are heightened, lending to the volatility; the performance chasers like action the that the housing stocks provide.

The increased volatility and poor response to positive fundamental metrics is drawing increasing amounts of attention from the market. The bears argue that the housing stocks trade at historically high premiums, while the bulls point to the positive data. The recent trend may be merely a case of "buying on the rumor and selling on the news." At the same time, though, the bears may be on to something bigger, especially of mortgage rates continue to drift higher.

The first sign of a change in trend can come from a reversal in relative strength. We focused on that much Monday in one of our intraday updates:

http://members.OptionInvestor.com/intraday/032502_2.asp

The next thing to look for when spotting a reversal in trend is an increase in supply and relatively lower highs in price. Using the $DJUSHB as our guide, we can observe a recent pattern of relatively lower highs developing. The latest sell signal I deem as meaningful as its magnitude was large, perhaps revealing a major long liquidation. A print at 344.00 from here would have the $DJUSHB back into a situation in which supply is greater than demand.

$DJUSHB PnF

It's important to note that despite the recent reversal in relative strength, the $DJUSHB is still on a buy signal versus the market (SPX.X). Moreover, the index trades well above its bullish support line. Those two facts alone take away from the bear argument.

The battle for control of the housing stocks is far from over and I predict that there will be many very tradable moves in the coming weeks and months, from both the bullish and bearish side. The most recent developments in the group could be a brief pause in the longer-term trend, or it could be the beginning of a major, major reversal. Either way, there's a lot of profit opportunity in the housing stocks from where I sit. Additionally, the $DJUSHB itself will serve as an excellent gauge for the strength of any economic rebound as it relates to the consumer.

Eric Utley
Option Investor

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