Don’t Be Fooled By These News Reports

by Michael Lombardi, CFP

Sure, banking stocks and retail stocks have been hit hard in this downturn. But it was the home builder stocks that started dow first in 2005.

From a peak of 1,100 in mid-2005, the Dow Jones U.S. Home Construction Index (an index comprising the world’s largest new home builders) fell an outstanding 87% by November 2008. In March 2009, when most major world stock market indices went even lower, the Dow Jones U.S. Home Construction Index failed to move below its December 2008 low, which was very positive.

The facts on the home building industry are quite well-known: New home prices have stopped going down, home builders are pulling out all the stops to get prospects into sales offices and reduced interest rates are bringing buyers back into the home market. Will prices for new homes rise? Of course not. Prices may not rise for years until the huge inventory of unsold homes is depleted.

Over the past three years, the major home builders have done a good job in cleaning their balance sheets and writing off raw land that they overpaid for. Profit per new home sold these days is not what it used to be, but sales are rising.

My loyal readers know my feeling that we are in a bear market rally. Stocks are rebounding from the severely oversold condition they reached on March 9, 2009. The Dow Jones U.S. Home Construction Index is trading at just over nine times last year’s earnings. I expect the group to have a better 2009 than they had in 2008, hence profits will rise.

If you are tempted to play this rally, then the home builder stocks, at this point, offer opportunity. The Dow Jones U.S. Home Construction Index currently trades at 242.45 and has the potential to rally into the 300 to 400 range during this market up-tick.

The home builder stocks are not out of the woods yet. But if an investor is looking to participate in the current bear market rally, the home builder stocks that were the most oversold last year may offer the best opportunity.

Michael’s Personal Notes:

Not all news must be bad for companies these days. Google Inc. (NASDAQ/GOOG) reported last night that it earned $1.42 billion in the first quarter of this year, beating analyst expectations. This morning, General Electric Company (NYSE/GE) reported that it made $2.7 billion in its first quarter, beating analyst expectations as well. These results bode well for the “feeling better” attitude starting to take hold of investors. Let the bear market rally continue!

At the end of today’s issue, you’ll find a feature article by our in-house historian Matt Gurney on why President Obama’s defense budget is good for the troops, but bad for the economy. I think you’ll find it a good read.

Where the Stock Market Stands:

More gains yesterday from the bear market rally. The Dow Jones Industrial Average is now down only 7.5% for 2009. My prediction that the Dow Jones would recoup all of its losses and then some for the year is boding well and I will stay with that prediction. Stocks became severely oversold on March 9, 2009, at the market low. This has been a classic bear market rally, but stocks are starting to get expensive again on a valuation basis. I see more and more advisors turning bullish, which is exactly what a bear market wants: Let everyone think we are out of the woods before the market goes down again. For now, let’s enjoy the rally and the profits it brings.

What He Said:

“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour waits…people are spending in America today at an unbelievable clip. 1932, 1933… who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we started experiencing in 2008 long before anyone else.