Value investors love to see capitulation - that magic moment when other investors can't take any more pain and swear off the stock market, or a particular stock, forever. At that point, stocks are at their cheapest.
The broader stock market has bounced sharply since hitting multiyear lows in early March, suggesting that capitulation has already come and gone, but housing stocks continue to languish near their lows.
Just how tempting are these stocks? We're talking about the publicly traded U.S. home builders here, namely: Centex Corp., D.R. Horton Inc., KB Home, Lennar Corp. and Pulte Homes Inc. They are all members of the S&P 500 home building index, which has fallen on hard times.
The index hit a high in July, 2005, and then fell 45 per cent by early 2007, foreshadowing the collapse of the broader market. Despite rising 65 per cent from its low point in November, 2008, the index remains near decade lows and is an amazing 84 per cent below its peak.
Clearly, these stocks are still in the dumps, and for good reason: After a number of false starts - in which observers turned bullish on home builders far too early, expecting a snap-back in the U.S. housing market that never came - the stocks have fallen off the radar screens of most investors.
Even normally upbeat analysts seem less than enthused. Among the 16 analyst recommendations on KB Homes, just two are "buy" recommendations; 11 are wishy-washy "hold" recommendations.
JMP Securities gives the stock a thumbs up, but the analyst, James Wilson, has had a laughable track record with his target prices in recent years. In 2005, he thought the stock would hit $102 (U.S.) within 12 months. In 2007, the target was $60. His target is $20 now. With KB Homes shares trading yesterday at $13.41, investors can be forgiven for ignoring JMP's target.
Hey, but that's a sign of capitulation - and there are actually a few other indications to suggest that home building stocks may be stabilizing.
For one, the share prices of the five big players have been in a relatively tight trading range since the end of 2007: 87 per cent of the decline in these shares occurred between 2005 and 2007, which means the decline over the past 18 months has been mild by comparison.
At the same time, the trading volume has picked up over the past 18 months, which suggests investors could be dumping their stocks at any price.
Finally, the number of shares sold short has surged recently for the SPDR S&P Homebuilders exchange-traded fund, meaning investors are betting this ETF will fall in value.
Yes, these are unsettling developments - but they are also contrarian indicators that suggest capitulation is near.
See David Berman's Market Blog at the new Globeinvestor.com