Homebuilders are on 'False Breakout' Watch

The homebuilders have not had a good start to the year. In fact, prices so far have not been able to surpass the December 31st highs in the SPDR S&P Homebuilders ETF (XHB). This brings up an interesting situation. You see, that late December rally in $XHB got prices above the May highs, which up until last month had been the highest levels since 2007 and an impressive 300% above the 2009 lows. But those fresh multi-year highs only lasted about a week. That's a problem.

The strength into the end of the year was sold right into to start 2014. This comes after a year that, although closed at new highs, underperformed the market for most of the year. The relative strength between the Homies and S&Ps deteriorated for most of last year, specifically in the second half. This is a sector you want to see leading (like in 2012), not lagging.

So all of this brings up a key question - Was that a false breakout in Homebuilders? Because if it was, this could be a big problem. Here's what I see. This is a weekly bar chart showing the new highs in December failing to hold while momentum has been rolling over:

For this false breakout to be invalidated, we need to see prices back above the May highs and momentum breaking out above this trendline into overbought territory. Otherwise, this one is guilty til proven innocent (from a trading and risk/reward perspective).

To me it's all about finding good risk/reward opportunities. If we're right on this trade, there is at least another 10% or so to the down side to get it back down to last summers lows. The risk is a couple of percentage points depending on your entry. But the best part about these 'false moves' is that the resulting action is typically fast and furious allowing the trader to profit rather quickly compared to other types of positions. Also, you're usually not sitting around waiting. You typically know whether you're right or wrong fairly soon. So the opportunity cost is low with these types of trades as well. That's something rarely accounted for.

Either way, I would expect the result of this situation to have some effect on the overall market. This is an important sector. I'm also watching retailers very closely here as they are also an important sector that has gotten off to a terrible start for the year. More on that soon.

Tags: $XHB