PulteGroup's Bearish Breakaway Gap

02/05/13 08:01:37 AM

by Donald W. Pendergast, Jr.

Shares of PulteGroup have enjoyed a massive runup in price since October 2011, but a new bearish breakaway gap is warning of a major reversal in trend.

Security: PHM
Position: N/A

Home construction stocks are among the more cyclical of stock industry groups, with some issues able to mount incredible rallies -- or declines -- in relatively short periods of time. Here's a look at PulteGroup (PHM), a recent high-flier stock from the construction services industry, which just printed a powerful bearish breakaway gap -- one that is very likely warning of a substantial trend reversal in the weeks and months just ahead.

FIGURE 1: PHM, DAILY. From the looks of the 100-day Chaikin money flow histogram (CMF)(100), the smart money traders in PHM were quietly distributing their shares to less-informed latecomers to PHM's incredible, 16-month-old rally.

Graphic provided by: TradeStation.

PulteGroup (PHM) achieved a major multicycle low on October 4, 2011, and after bottoming out at the bargain basement price of 3.29, the stock went on to soar more than 567% by January 28, 2013, when it hit $21.97. That's a noteworthy trend move in anybody's book, but the unexpected arrival of a major intraday reversal (down by more than 5% in early morning trading) and bearish breakaway gap may now be signaling the death knell for PHM's powerful bull run (Figures 1 and 2).

PHM, like many large-cap stocks, tends to spend most of its time trading within the bounds of its two inner Keltner channels (red bands); the stock's latest surge upward since mid-November 2012 was only able to make a few daily closes above the band, with the bears ready to sell short at a moment's notice.

The decision to start dumping PHM shares en masse on January 31, 2013, was made easier due to the fact that PHM's long-term money flow has been confirming multiple degrees of distribution (the smart money selling out on the rallies, with the dumb money buying their shares). All that was needed to ignite a vicious round of selling was a bit of bad economic news, an earnings miss, and so on, and the stock was likely to decline, no matter what the precipitating news or economic event actually was.

Incredibly, PHM reported better home sales numbers and quarterly earnings, and the market responded by beating the tar out of the share price after the news was released before the market opened on January 31! This looks like the old Wall Street adage "Buy the rumor, sell the news," perhaps? Apparently, in PHM's case, not even great sales and earnings results were enough to overcome the combined negative technicals of waning long-term money flow and Keltner resistance, and the stock is now on course to embark on a major corrective move.

FIGURE 2: RELATIVE STRENGTH RANKINGS. Relative strength rankings confirm the strength of PHM's performance over the past year; look for this stock's four-week performance numbers to decline rapidly during February 2013.

Graphic provided by: TradeStation.

Graphic provided by: TradeStation Radar Screen.

The gap lower may be tentatively labeled wave A, with a subsequent relief rally becoming wave B. One way for aggressive traders to play PHM here may be to simply buy in-the-money puts with two to three months of time value on a decline beneath $19.10, holding on for a high-probability ride south down toward the next support level at $17.30.

More conservative traders should probably wait for a pullback up toward the bottom of the open gap before deciding to sell puts, using the same $17.30 profit target. The April '13 PHM $21 and $22 puts look like they could be useful trading vehicles for such speculative purposes and will provide a bit more staying power than the $19 or $20 ones.

Wide-range breakaway gaps occurring at the top of a gigantic bullish run almost invariably lead to sharp, protracted declines in a stock, and this time around, it's likely going to result in sharply lower prices for PHM heading into February 2013.

Donald W. Pendergast, Jr.

Freelance financial markets writer and online publisher of the Trendzetterz.com S&P 500 Weekly Forecast service.

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PulteGroup's Bearish Breakaway Gap

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