A timely correction and continued good numbers from the sector is training the smart money on homebuilders, writes Jordan Kimmel of Stock Trader's Almanac.
When our Magnet Stock Selection Process uncovers a cluster of stocks in the same sector at the top of our rankings, it usually indicates something of greater magnitude is brewing.
What we see right now is an opportunity in the housing sector. It looks like this housing recovery is for real.
We are seeing margin expansion in subgroups—from lumber suppliers to entry-level and high-end homebuilders, as well as mortgage providers. As weird as it sounds, at the same time, we are hearing questions such as: "Is this another housing bubble?" and "Who has the money to buy?"
While housing prices first stabilized over a year ago (when the big money went in and bought distressed properties), now they are on the rise again. One reason is that the affordability index (rent vs. buy) is now pushing renters into becoming buyers. Large institutions are buying blocks of 100 homes at a time. We are also seeing foreign buyers with cash disrupting old ideas of value.
Many of today's investors don't even know the acronym RTC. When the Resolution Trust Corporation was in the news every day in the 1980s, very few expected the housing market to ever look appealing again.
But once investors cleared the supply, the housing market entered into another sustained bull market that ran for about 15 years from 1991 to 2005. Housing cycles last a while, and that is why my guess is the consolidation fireworks are about to go off!
I am not even sure how the consolidation phase in housing stocks will take place. I do not try to "find takeover candidates." Instead, I use my Magnet Process to identify the companies in every sector that have the best fundamentals—improving revenues, cash flow, and profit margins.
These companies are usually smaller and make great acquisitions for the larger companies with large cash reserves, but are currently slower growers.
With money so inexpensive and the housing sector showing strength, I expect to see some significant deals to take place soon. I was looking for a correction in this sector to go in and buy a few of the top-ranked Magnet stocks in the group, and we got it.
My Almanac partner, Jeffrey Hirsch, reminds us that the housing sector as represented by the Morgan Stanley REIT Index has declined from May to October, about 5% on average since 1996. Since its May 22 intraday high to its recent low, it's down about 14%.
In addition, the rather predictive NAHB Housing Market Index—arguably the best indicator for judging the overall health of the housing market—was 52 for June, up from 44 in May. HMI has been on the rise since late 2011. Ratings above 50 indicate a more positive bias in home sales and buyer's traffic.
Experience tells us the retail investor that was waiting for a pullback will now sit on their hands too afraid to buy. Cool-headed insiders in the industry with access to huge cheap capital, who understand the demand for homes, have the opportunity to swoop in and buy. That's exactly what I expect.
As portfolio manager of the Magnet AE Fund, I am currently long DR Horton (DHI), Ocwen Financial (OCN), and Ryland Group (RYL).
Read more from the Stock Trader's Almanac here...
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