2 Solid Picks for the 3rd Quarter

The second quarter proved to be full of mixed results, so MoneyShow's Tom Aspray takes a technical look at two stocks in the out-of-favor homebuilder sector that may surprise the majority by the end of the third quarter.

The second quarter ended on a mixed note with the Dow Industrials and S&P 500 a bit lower while the market internals were positive and the NYSE Advance/Decline line made another new high.

Monday's economic data was mixed as-while the Chicago PMI was weaker than expected-the Dallas Fed Manufacturing Survey reflected nice growth with increasing optimism on business conditions. The Pending Home Sales Index showed an impressive 6.1% increase.

Nevertheless, the market participants are still cautious, especially with the heavy slate of economic data and the fear that Thursday's jobless claims will disappoint the market. The arguments of the past few months persist; stocks are expensive, the economy is actually weak, and it has been too long since a market correction.

Many of the actively managed funds have been hurt by their manager's skepticism as 74% of the actively managed funds that concentrate on large-cap stocks are lagging the S&P 500. Those small- and mid-cap managers are also trailing their benchmarks.

Though over 76% of the S&P 500 stocks are above their 50-day MAs, only 7.8% are making new 52-week highs, which is less than half of the reading from early June. It is also well below the mean of 14.8% and the late-2013 peak of 23%.

The homebuilders are one out-of-favor group that looks ready to move, basis the charts and the volume analysis. A look at the monthly and daily charts of these two picks illustrates why they could surprise the majority by the end of the 3rd quarter.

Click to Enlarge

Chart Analysis: Just over a week ago, I took a technical look at the iShares Dow Jones Home Construction ETF (ITB) as I have been monitoring the weekly flag formation, which favored an eventual upward resolution.

• The monthly chart shows key resistance at the February high of $26.56, line a.
• The monthly starc- band is now at $29.29.
• An upside breakout has chart targets in the $31-32 area.
• ITB tested the 20-month EMA in May, which is now at $22.57.
• The relative performance peaked in late 2012 and is currently below its WMA.
• The RS line shows a pattern of lower highs, line c, while the weekly (not shown) could move back above its WMA this week.
• The monthly OBV has been above its WMA since September 2013 when ITB closed at $22.34.
• On the recent pullback, the OBV held well above its WMA before turning higher.
• The quarterly OBV (not shown) is also above its WMA. For the 3rd quarter, the pivot is at $24.22 with the R1 resistance at $25.85.

The daily chart of the iShares US Home Construction ETF (ITB) shows a gradual uptrend, line a, as it has tested its 20-day EMA on four of the five past days.

• The daily starc- band is at $25.31, which is just above my previously recommended buy stop level at $25.07.
• The daily relative performance is now testing short-term resistance at line f.
• The RS line needs to move above the early-June high to indicate it is a market leader.
• Much more impressive is the recent volume action as the sharp rise in the OBV is consistent with heavy accumulation.
• The downtrend in the OBV, line h, was broken in early June and was followed by a brief drop below its WMA.
• In Monday's trading ITB opened unchanged at $24.65 and tested the monthly pivot at $24.55 before closing higher.
• There is further support in the $24-$24.26 area.
• A drop below the $23.72 would move ITB back into its range.

NEXT PAGE: Another Stock That Could Surprise

Click to Enlarge

The monthly chart of D.R. Horton (DHI) shows that the major 61.8% Fibonacci resistance from the July 2005 high at $42.82 was tested in May 2013 when the homebuilding stocks topped.

• Over the past four months the rising 20-month EMA, now at $21.06, was tested.
• The monthly uptrend, line a, is $20.12.
• The quarterly projected pivot resistance is at $27.28 with the monthly starc+ band now at $29.50.
• The monthly RS line has been rising for the past few months and is just barely below its WMA.
• It has formed higher highs, line b, and a breakout above resistance, at line b, would be very positive.
• The monthly OBV dropped below its WMA during the 2013 correction but has now broken out to the upside as resistance, at line d, has been overcome.
• The OBV is leading prices as it is already well above the 2013 highs.

The daily chart of D.R. Horton (DHI) shows the strong close Monday, which was just below the breakout level at $24.83-$25.02.

• The monthly projected pivot resistance is at $26.05 and a completion of the four month trading range has upside targets in the $29-$30 area.
• The daily relative performance has turned up sharply with Monday's close.
• The RS line has been acting stronger than prices since April, line h.
• The daily on-balance volume (OBV) just flipped back above its WMA generating an AOT buy signal.
• Further strength and increasing volume are needed to confirm the recent positive action.
• For July, the monthly pivot is at $24.09 with the 20-day EMA at $23.74.
• There is more important support at $23.36, which is the monthly projected pivot support.

What it Means: I have been watching the homebuilding stocks closely for the past few months as they were out of favor,as well as being important to my view of an economy that was going to get even stronger.

As per previous recommendations long positions have already been established in PulteGroup, Inc. (PHM) and also in Lennar Corp. (LEN), which was featured in Advanced Entry Techniques for Any Market.

If you are long these stocks, I would suggest skipping a new long position in DHI as it may be too heavy a commitment to one industry group.

How to Profit: For iShares Dow Jones Home Construction ETF (ITB) go 50% long on a buy stop at $25.07 and 50% long at $24.72 with a sell stop at $23.67 (risk of approx. 4.9%).

For D.R. Horton (DHI) go 50% long at $24.41 and 50% long at $23.76 with a stop at $22.96 (risk of approx. 4.9%).

For PulteGroup, Inc. (PHM) now 50% long at $19.77 and would use a stop at $19.12.

For Lennar Corp. (LEN), should be 50% long at $41.44 and 50% long at $40.81 (last Friday's low was $40.80) with a stop at $39.44.