ITB GIVES PURER HOMEBUILDING PLAY THAN XHB -- HOUSING STOCKS TELL US SOMETHING ABOUT THE HOUSING INDUSTRY -- SECOND EDITION OF THE VISUAL INVESTOR MAKES FOR GOOD SUMMER READING -- TWO WEEK HIATUS

ITB VERSUS XHB... On Monday, I wrote a bullish message on the homebuilding group and suggested using the SPDR S&P Homebuilding ETF (XHB) as one way to participate in the housing recovery. I pointed out, however, that the XHB has a relatively heavy weighting in a lot of housing-related stocks that aren't necessarily homebuilders (like Home Depot, Bed Bath & Beyond, Masco, etc.). A purer homebuilding play can be found in another ETF -- iShares Dow Jones U.S. Home Construction (ITB) -- which is shown in Chart 2. The two charts are basically similar, show the same bottoming characteristics since last November, and are both on the verge of breaking out to the highest levels in nine months. On percentage grounds, however, the ITB has an edge. Since the start of 2009, the ITB has gained 23% versus 19% for the XHB (the S&P 500 has gained 9%). Since the March bottom, the ITB has rallied 87% versus 74% for the XHB (and 44% for the S&P 500). The top holdings in the ITB are homebuilders like NVR, DR Horton, PHM, Toll Brothers, Lennar, and Centex. The XHB offers participation in a broader array of housing-related stocks. If you want a purer homebuilding play, however, ITB would be the better choice.

Chart 1

Chart 2

HOUSING CHARTS LEAD HOUSING FUNDAMENTALS... My Monday message also included the view that a bottom in housing stocks was signalling a bottom in the housing industry as well. Some of the feedback I got questioned the validity of using stock prices to predict the fundamentals of housing. My response is to point out that to question the use of stock prices to forecast fundamentals questions the entire premise on which technical analysis is based, which is that stock prices lead fundamentals. This is true not only of housing, but of every other industry and market sector. It's also true of the market as a whole which changes direction (both up and down) six to nine months before the economy. If you read back through my Market Messages as early as 2005, you'll see many headlines describing a top in homebuilding stocks and the housing industry. A November 8, 2005 Message, for example, carried the headline: Homebuilders Weigh on Market -- Double Top In Bond Prices Signals End of Five-Year Housing Boom". An August 4 message that same year is headlined "Housing Leadership May be Slipping", which was followed by an August 23, 2005 Message: Homebuilders Weigh on Market -- Housing Index Looks Toppy". The weekly bars in Chart 3 show the peak in the PHLX Housing Index (HGX) in the middle of 2005 which was followed by a major downturn in the spring of 2006. The HGX/SPX ratio (solid line) shows the HGX starting to underperform the S&P 500. I interpreted the peak in homebuilding stocks as an early sign that the housing boom was coming to an end and would eventually prove harmful to the stock market and the economy. At the time housing stocks were peaking, the "fundamentals" were still viewed as positive. We now have the exact opposite situation. The weekly bars in Chart 4 show the Housing Index in the process of forming a chart bottom. The HGX/SPX ratio (solid line) bottomed last November and is now rising. In other words, housing stocks are leading the market higher. That's a good sign for the stock market and the economy. But it's an especially encouraging sign for the housing industry.

Chart 3

Chart 4

SUMMER READING ... One of our readers recently asked for suggestions for summer reading. My recommendation would be my most recent book: "The Second Edition of the Visual Investor". The book explains the role of visual (or technical) analysis as a leading indicator of economic and fundamental information, and gives numerous examples of how that has worked in the past (including the 2007 market top). It also explains how the top in housing led to that stock market top. It updates my views on intermarket linkages which include reasons why bond and stock prices have remained decoupled over the last decade and why stock and commodity prices have become more closely linked. It explains how to use Exchange Traded Funds to implement asset allocation and sector rotation strategies on both sides of the market (including foreign markets). It also includes an explanation of all of the Stockchart indicators that I use in my Market Messages. The Second Edition of the Visual Investor will give you a solid understanding of why visual analysis works and how best to make it work for you. A better understanding of the subject will also help you better understand our daily Market Messages. I've also been told that it's pretty easy reading.

Chart 5

SUMMER HIATUS... On that educational note, I'm leaving on a two-week hiatus to recharge my batteries and catch up on some summer reading of my own (although not necessarily about markets). Arthur Hill will keep you on informed on market developments.