Investors in homebuilding stocks have enjoyed a massive run-up since October that has left major indexes in the dust.
But with several companies in the sector reporting earnings next week, there is concern there may not be enough growth ahead to support current valuations in a sector that has seen many false dawns in the past five years.
"They are rallying more on hopes than on reality," said Gary Shilling, president of investment research firm A. Gary Shilling & Co.
The possibility of a pick-up in foreclosures and the resulting build-up in inventories could be a major headwind for profits, he said.
D.R. Horton Inc
Many of the stocks, notably KB Home, Hovnanian Enterprises Inc
The activity in the options market also suggested caution as the stocks can be volatile around events such as earnings.
Investors have gotten mixed reports about the spring season so far. Lennar Corp
The SPDR S&P Homebuilders exchange-traded fund (ETF)
"I think that the broad economic recovery created an inevitable snap-back in the fortunes of homebuilders, with many investors easily sold on the prospects for happier times for the industry," said Andrew Wilkinson, chief economic strategist at institutional trading firm Miller Tabak & Co.
"Unfortunately," he added, "those prospects are less likely to evolve, given the new hurdles to the industry."
He cited foreclosures, debt hangover from the past housing collapse and high down payments for homebuyers as imminent challenges.
Spring is usually the equivalent of Christmas for homebuilders. But a surge in selling has yet to materialize in a sector that remains mired in the worst slump since the Great Depression.
Data on Thursday showed U.S. home resales fell in March but the supply of properties tightened and prices edged higher, giving mixed signals about the pace of recovery.
Consumers remained skittish as they face a shaky labor market, high gas prices and a volatile U.S. economy.
It is now cheaper to own than to rent across the United States, with mortgage rates near record lows and inventories at record highs. Still, many first-time homebuyers are saddled with student debt and a big chunk of their paychecks are gobbled up by rent, so they are shut out of homebuying altogether.
For homebuilder stocks, the headwinds, reflected in the mixed housing data, could make it hard to keep pace with the recent uptrend.
Susquehanna Financial Group homebuilders analyst Jack Micenko downgraded Toll Brothers Inc
BEARISH BETS ABOUND
Short interest positions have been building in several homebuilders. Three out of every four KB Homes shares available for lending are effectively on loan, which amounts to approximately 41 percent of the total free float, according to Data Explorers, a research firm.
More than one-half of loanable Hovnanian shares are being shorted, and roughly one of every three is being shorted on both PulteGroup and Ryland.
Ryland has also triggered a very bearish score in SentimenTrader.com's ranking of investor sentiment. According to the list, Ryland had a more bearish score than 98 percent of the S&P 1500 components.
"It has the most consistently negative readings across the various measures we track, suggesting the pessimism is pretty widespread," said Jason Goepfert, president ofSentimenTrader.com.
Sentimentrader.com uses seven measures for each stock, including short interest as a percentage of a stock's average trading volume.
On the same ranking, PulteGroup scores a more bearish sentiment than 95 percent of the S&P 1500.
One effect of the negative sentiment is that a reaction to any upside earnings surprises could be enhanced.
"If there is any good news after earnings, the shorts could be forced to cover their positions, thus providing a potential explosive move higher," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.
Another signal of bearish sentiment is seen in the options market.
Overall trading has been slightly below average, but the flows in options pits suggested a sharp shift in favor of puts, or contracts that give the holder the option of selling shares at a given price by a certain date. This type of play, dominant in the last two weeks, generally expresses expectations for a stock to fall.
Some 338,000 puts and 174,000 calls traded in the sector in the two weeks ended April 17, a put-to-call ratio of nearly two.
"Historically the put-to-call ratio for the sector is below 1, so this is pretty noteworthy," said Henry Schwartz, president of options analytics firm Trade Alert.
Derivative strategists at Susquehanna said Wednesday they also have seen "a fairly consistent trend of protective trading" in the SPDR S&P Homebuilders ETF as well as in PulteGroup, Horton, Lennar and Ryland in recent weeks.
In terms of individual stocks, data from Schaeffer's Investment Research indicated a high number of Horton put open positions, relative to calls near term ahead of earnings.
Schaeffer's data showed Horton's open interest puts outnumbered calls by more than two-to-one in the front three months. The ratio is higher than 90 percent of the readings over the past year and suggested a good deal of pessimism heading into its earnings report next week, said Detrick.
