Dear Bottarelli Research Reader,
This week, I’d like to address one of Wall Street’s little frauds. This isn’t just an old guy whining. It actually reveals a dangerous money trap, which in turn leads to a decent opportunity.
Here’s the deal…
A few weeks ago I wrote about an incipient breakdown in real estate, and used the chart for the SPDR S&P Homebuilders (XHB – NYSE) to demonstrate my point.
That was a mistake on my part, and I apologize for it, because the XHB has to be the absolute worst example of a homebuilders ETF.
The official description claims that the XHB “seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of an index derived from the homebuilding segment of a U.S. total market composite index.”
One might think that they would achieve that by buying shares of, say, homebuilders, and then re-selling composite shares of the total ETF, right?
Wrong!
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Where Did All the Builders Go?
Maybe the XHB’s managers used to align directly with the builders – but have lately succumbed to the pressure to produce excess gains. So, they’ve salted their fund from the hottest sector they could find – retail stocks!
Case in point, here’s the list of the XHB’s top 10 holdings, representing some 34.91% of the fund’s total assets.
| Holding | % of Fund |
| Lumber Liquidators (LL – NYSE) | 3.68% |
| Lennox International (LII – NYSE) | 3.66% |
| Lowe’s (LOW – NYSE) | 3.53% |
| Bed Bath & Beyond (BBBY – NASDAQ) | 3.51% |
| Mohawk Industries (MHK – NYSE) | 3.49% |
| AO Smith (AOS – NYSE) | 3.49% |
| Williams-Sonoma (WSM – NYSE) | 3.45% |
| Whirlpool (WHR – NYSE) | 3.38% |
| The Home Depot (HD – NYSE) | 3.36% |
| Fortune Brands (FBHS – NYSE) | 3.36% |
Now, look again.
Yeah that’s right, there isn’t a single genuine homebuilder in this entire batch.
Sure, there are connections to the trade if you squint a bit, but the parallel is as loose as you can possibly imagine. For instance…
- Lennox and AO Smith make HVAC units and water heaters, while Fortune makes windows, doors and locks.
- Mohawk makes flooring and Lumber Liquidators is a discount flooring retailer.
- Whirlpool probably makes more washers and dryers for aftermarket sales than for new homes these days.
- Lowes and Home Depot are broad market hardware stores – that market as much to after-market as to builders.
- And for Pete’s sake, William-Sonoma and Bed Bath & Beyond sell sheets, pillows, and wine corkscrews.
The Missing Signal
Let’s go back to that XHB chart I showed you a while back. The whole chart (below) is dominated by a clear 3x Sell Signal back in June.
The upper chart’s Head & Shoulders pattern is still playing out, with its rising series of highs (the left shoulder and head) interrupted by a weaker right shoulder. This indicates the end of a rising trend and points toward a descent to $23.22.
We also see the same vanishing volume that is plaguing the larger market. (We’ll get into that more at the end of today’s newsletter.)
What we don’t see is a complete breakdown — yet.
But that’s not because builders are doing so well right now. Rather, it is because retailers are weighted more heavily than builders in this ETF!
And this presents a whole different set of problems that we recently addressed in Bottarelli Research LEAPS.
But today, I want to correct our forecast for homebuilders. To do that we need a better proxy for the business.
A Pure Play
Take a good look at one of the XHB’s rival ETFs, the iShares Dow Jones US Home Construction (ITB – NYSE).
Much like the XHB, the official description has the ITB “seeking investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones U.S. Select Home Construction Index.”
To achieve this, the managers of the ITB did something that apparently didn’t occur to the folks at XHB – they bought up some homebuilders!
Here are the top 10 holdings for the ITB, representing 62.68% of the fund’s total assets, and their percentage of the total fund.
| Holding | % of Fund |
| PulteGroup (PHM – NYSE) | 10.13% |
| Lennar (LEN – NYSE) | 9.50% |
| D.R. Horton (DHI – NYSE) | 9.45% |
| Toll Brothers (TOL – NYSE) | 8.13% |
| NVR (NVR – NYSE) | 7.25% |
| Home Depot (HD – NYSE) | 4.82% |
| Lowe’s (LOW – NYSE) | 3.70% |
| Ryland Group (RYL – NYSE) | 3.67% |
| KB Home (KBH – NYSE) | 3.25% |
| Meritage Homes (MTH – NYSE) | 2.78% |
Other than Home Depot and Lowe’s, every single name on this list actually builds houses for a living. And when you look at the chart for this pure play on builders, you see the same 3x Sell Signal Stack, the same vanishing volume, and the same Head & Shoulders pointing toward the 50% retracement marker at $17.17.
But, you also see a confirming Death Cross, wherein the 50-day (10-week) average has crossed under the 200-day (40-week) average – a strong confirming downside signal that should be familiar to all investors.
The difference between the XHB’s muddy signals and the ITB’s clear downside indication results directly from the XHB’s mixed holdings versus the ITB’s pure list of builders.
And, we intend to use this clear signal in this week’s Bottarelli Research LEAPS recommendation to generate a put option play that ought to bring in 25% to 50% gains over the next few weeks.
The Current Situation
As we promised above, here’s the analysis of the Dow Jones Industrials (DJIA), including the vanishing volume we spoke of.
For weeks, we’ve called for a rollover at the top of trend — and for weeks, all the signals but one were with us. But now, all the signals are finally lining up.
On the upper chart, we see the second red candle in seven weeks, and it has finally broken back of the rising trend.
Volume is in a parabolic downturn as traders abandon stocks. Seriously, there must be tumbleweeds rolling along the exchange floor right now. This is what was driving UBS’ Art Cashin’s recent complaint that “there is no money to be made in this market.”
There is no longer any doubt about MACD’s Sellers Cross. And, the lagging Accumulation/Distribution oscillator has finally flipped sharply down to indicate the beginning of a steep share sell-off.
We are not yet calling for the Storm of the Century. But, I am willing to put up gale warning flags. Before this next blow is over, the Dow could easily be sitting on the floor of its range at the 38.2% retracement marker at 14,429.
And some pretty smart guys like Bull and Bear Partners’ Jack Bouroudjian are calling for a -10% to -15% retreat.
As always, the charts tell all.
Sincerely,
Adam Lass
Bottarelli Research Newsletter
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