HOMEBUILDERS NEAR TEST OF NECKLINE IN POTENTIAL HEAD AND SHOULDERS TOPPING PATTERN

LENNAR MAY BE IN FINAL STAGE OF MAJOR TOP ... More bad news from Lennar pushed homebuilders, REITs, and financial stocks lower today. Given the daily focus on the housing sector, this is as good a time as any to take a longer-term look at at the group. Unfortunately, the longer-range picture raises some serious concerns. Let's start with Lennar. The monthly bars in Chart 1 show that the uptrend since 2000 is still intact, but just barely. Chart 1 shows Lennar moving closer to its seven-year up trendline sitting near 40. Downside volume has picked up during March as prices have fallen. The monthly MACD lines have been negative since the middle of 2005. The box in Chart 1 contains the price action since the start of 2004. Chart readers will recognize the three-year price pattern in the box as a potential "head and shoulders" top. Chart 2 shows that potentially bearish pattern more clearly.

Chart 1

Chart 2

HEAD AND SHOULDERS TOP FOR LENNAR?... Let's review what a "head and shoulders" top is. First of all, it occurs after a bull market has been in place for awhile. It's completion often corresponds with the breaking of a major up trendline. [Take a look at the weekly bars in Chart 2 as you read this]. The H&S pattern has three peaks. The two surrounding peaks (called ""shoulders"") usually top at the same point (in this case 55), while the middle peak (the head) is higher than the two shoulders. [Sometimes, as was the case with Lennar, the "head" forms a small H&S top of its own (see circle)]. A line drawn below the two troughs is called a "neckline". Most valid necklines are either flat or have a slight upward slope. Based on what I've described so far, Lennar qualifies as a texbook "H&S top". [I can say that because I wrote the textbook]. The real key is the test of major support near 40. The stock appears headed toward that level. A decisive violation of that support level would complete the bearish topping pattern and break a seven-year support line. That's pretty bearish.

DOW JONES HOME CONSTRUCTION INDEX LOOKS THE SAME ... In case you're wondering if the potentially bearish pattern in Lennar holds true for the entire homebuilding group, take a look at the next two charts. They plot the Dow Jones US Home Construction Index. Chart 3 shows the same potential "head and shoulders" top forming in that industry index. Chart 4 puts that topping pattern in a longer-term perspective. I've used logarithmic scales on both charts. Long-term trendlines are usually broken earlier on log charts. That's certainly the case with the home construction index in Chart 4. There's no guarantee that the bearish H&S patterns will come to fruition. But they're clearly visible and can't be ignored either. At the very least, they provide a reality check on the usual Wall Steet (and television) claims that the housing problem won't get that serious. It might if those necklines are broken.

Chart 3

Chart 4