A “Contrarian” Bet on U.S. Homebuilders

It was yet another lousy week in global stock markets, with the Dow Jones down 1.80% and the S&P 500 tumbling 2.11%. The MCSI Emerging Markets Index continued its relentless fall, tumbling another 4.83%.

The sole bright spot in your portfolio was Sony (SNE), which ended the week up 2.52%.

As uncomfortable as the recent sell-off has been, I believe that markets are overreacting to Federal Reserve Chairman Ben Bernanke’s announcement that the Fed will gradually begin to wind down its quantitative-easing (QE) program. Once the markets adjust to this reality, I believe they will stabilize and resume their upward trend.

My biggest concern globally is the banking system in China, which is teetering and may have wide-ranging, unintended consequences across a broad span of global markets. That said, your exposure to China or emerging markets is tangential at best through your holding in Melco Crown (MPEL).

So this week’s Bull Market Alert recommendation — the iShares Dow Jones US Home Construction (ITB) — focuses on a sector in the United States that has become extremely oversold, yet I believe it has strong fundamentals.

The iShares Dow Jones US Home Construction (ITB) tracks the Dow Jones U.S. Select Home Construction Index. Its biggest holdings include PulteGroup, Inc. (PHM), Lennar Corporation (LEN), D.R. Horton, Inc. (DHI), NVR, Inc. (NVR) and Toll Brothers Inc. (TOL), which together account for 44.73% of ITB.

ITB has fallen 13.49% (7.66% just last week) since hitting its peak on May 20. Investors’ knee-jerk reaction has been that higher interest rates will stop the housing recovery in its tracks.

Yet, I think the opposite is likely to happen. As interest rates begin to rise, potential homebuyers will act sooner than later, encouraged by rising retail sales and consumer confidence. I bet many consumers are already plugging in 4.5%, 5%, 6% figures into their mortgage calculators, spurring them to act sooner, rather than later. In addition, more normal, market-determined levels may also encourage banks to allocate more funds to mortgage lending and reduce their abnormally stringent mortgage-lending standards.

For the longer term, the big-picture case for housing is extremely strong. Existing-home sales for May were up 4.2% from April to an annual rate of 5.18 million — above the 4.97 million consensus estimate. Over the past 12 months, total housing starts were up 28.6% and single-family starts rose 16.3%. Applications to build single-family homes are at their highest level since May 2008. Small trucks favored by construction workers are flying off the lots. Population growth in the United States is creating demand for 14 million more houses over the next five years. Yet fewer than 6 million will be built by 2015.

So, buy iShares Dow Jones US Home Construction (ITB) at market today, and place your stop at $18.25.

If you want to play the options, I recommend the October $22 calls (ITB131019C00022000).

Portfolio Update

Bank of Ireland (IRE) lost 6.74% last week. Bank of Ireland took another step along the road to recovery last week as Deutsche Bank issued an upgrade on the stock. With its Relative Strength Index (RSI) at 19.5, IRE is extremely “oversold” by this widely used measure. Couple this with the rapidly approaching 200-day moving average, and IRE is due for a strong bounce. IRE is a HOLD.

Melco Crown Entertainment Limited (MPEL) fell 6.68%. MPEL was listed among the “Best Managed Companies in the Philippines” in the FinanceAsia publication’s 13th annual poll of the top Asia companies. Dipping below the 50-day moving average, MPEL changes to a HOLD.

Delphi Automotive (DLPH) lost 2.99% over the past five trading days but still managed another new 52-week high before the market-wide selling began — complements of Fed Chairman Ben Bernanke. Shares remain very near their 52-week high, and DLPH is likely just one more “baby thrown out with the bath water” in the recent market correction. DLPH remains a BUY.

Stratasys Ltd. (SSYS) dipped 2.38%, side stepping much of the selling carnage last week. Stratasys formalized its merger with MarketBot, which strengthens Stratasys’ desktop printing offerings in the 3D-print marketplace. SSYS remains a BUY.

Jazz Pharmaceuticals (JAZZ) fell 5.26% last week. JAZZ holds a coveted spot on the esteemed Investor’s Business Daily “IBD 50” list, making it into the top five-listed biotech and drug stocks. JAZZ has boasted double and triple quarterly sales growth for three straight years. JAZZ is a BUY.

Sony Corporation (SNE) emerged as your Bull Market Alert portfolio’s strongest performer last week, managing a 2.52% gain in the face of an otherwise horrific week for markets across the globe. Daniel Loeb, founder and chief executive of the $13 billion Third Point LLC hedge fund, is making waves after issuing a proposal to Sony suggesting that the company conduct an initial public offering (IPO) of up to 20% of Sony’s movie and music businesses. As owner of 7% of Sony’s shares, Mr. Loeb’s proposal to unlock value is being considered by Sony’s board of directors. SNE is a BUY.

Latest Special Reports

As a courtesy, I want to bring to your attention my latest special report, Hedge Fund Secrets Revealed: A Simple Four-Step Technique to Manage Your Money like a Hedge Fund. This FREE report gives you the four-step process to maximize your profits just like the best investment pros do.

In addition, take a look at the latest version of The Top 12 Stocks You Should Buy Right Now, which features three of my top investment recommendations, as well as bonus picks from each of my fellow investment newsletter editors at Eagle. Both of these special reports are accessible FREE on my website.