Homebuilding stocks leapt to higher ground in the third quarter, underpinned by the rapid collapse in bond yields. Lower mortgage rates have made buying first homes more affordable for the millennial generation, who have had prior applications denied by risk-averse lenders. Look for this beneficial trend to expand in coming years, with increasing wages and mid-life nest-building adding to the surge in new and existing home sales.

Even so, it’s important to choose long-term sector exposure wisely because home sales growth is a regional rather than national phenomenon, with East and West Coast builders benefiting from local prosperity while large swathes of Middle America face continued headwinds from the loss of manufacturing and service jobs due to globalization and the relentless advance of artificial intelligence.

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The iShares US Dow Jones Home Construction Index Fund (ITB) is trading at a critical level that could affect the weakest components in the fourth quarter. The fund came public near $50 in May 2006 and entered an immediate downtrend that posted an all-time low at $6.33 in March 2009. The subsequent uptrend stalled four points under the all-time high in 2017, while price action into October 2019 has been absorbing gains posted after the 2016 election.

The rally ended after clearing the .786 Fibonacci sell-off retracement level, reestablishing resistance in the low $40s. More importantly, the recovery wave since the pullback ended in December 2018 has now reached the .786 retracement of that smaller-scale decline. This symmetry between time frames often provides an early warning signal for selling pressure that could be matched by a continued pullback in the bond market.

Even so, the strongest components could avoid pain if the homebuilding sector turns lower, with long-term fundamentals outweighing technical headwinds.¬†Stocks that are trading at or near multi-year highs look like best bets in this mixed environment, with M.D.C Holdings, Inc. (MDC) and Pulte Group, Inc. (PHM) leading the charge. At the same time, it’s best to avoid big names D.R. Horton, Inc. (DHI) and Lennar Corporation (LEN) because they remain stuck under 2018 resistance.

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Colorado’s M.D.C Holdings broke out above the 1986 high at $13.24 in 2001 and entered a powerful trend advance that posted an all-time high at $82.99 in 2005. The subsequent downtrend continued through the 2008 economic collapse, finally coming to rest at a 10-year low in the lower teens in 2011. The subsequent recovery wave stalled under $40 in 2013, setting a resistance level that broke to the upside in September 2019.

This breakout establishes support that should limit downside risk for new positions. The uptick has just reached the 50% retracement of the six-year downtrend at the same time that accumulation readings are hitting new highs, predicting relatively easy upside into the .618 retracement level near $50. Pullbacks into the upper $30s can also be bought in this two-sided set-up, while plenty of room into last decade’s all-time high may support a multi-year buy-and-hold strategy.

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Atlanta’s Pulte Group posted impressive gains in the 1990s and first years of the new millennium, lifting from a split-adjusted 75 cents in 1990 to 2005’s all-time high at $48.22. The stock crashed into the single digits during the 2008 economic collapse but failed to bottom out until 2011, when it posted a 15-year low just above $3.00. The subsequent bounce stalled in the mid-$20s in 2013, generating a resistance level that finally broke to the upside in 2017.

The stock topped out with the homebuilding sector in the first quarter of 2018 and fell to a 22-month low in December. It has outperformed so far in 2019, carving a V-shaped rally that broke out to a 13-year high in September. Even so, it is now trading less than two points under the .786 retracement of the six-year downtrend, suggesting that market players wait for a pullback that tests breakout support before jumping on board.

The Bottom Line

Homebuilding stocks roared higher in the third quarter and could add to gains after a fourth quarter testing phase.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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