Homebuilders Fading Fast

I have another relative-strength chart to share today… one you haven’t seen before.

It shows exactly how overvalued homebuilder stocks have become since the faux housing recovery began boosting their share prices in October 2011.

I created the chart using a simple ratio:

Price of the Homebuilders ETF (NYSE: XHB)
Price of the S&P 500 ETF (NYSE: SPY)

Since last October, SPY is up 15%. Meanwhile, homebuilders’ stocks have gained anywhere from 53% to 400%!

This, naturally, caused the XHB:SPY ratio to climb from October 2012 through March of this year. Take a look…

See larger image

After topping out, this ratio started falling in May, right along with the steep rise in interest rates. But that’s old news.

The real question now is this: How much excess value must be worked off of homebuilder stocks before they realign with reality?

Fibonacci retracement levels help me answer that…

In the chart above, I’ve drawn the standard retracement levels in blue, green and yellow. So far, we’ve retraced just 22% of the trend. Conventional wisdom says that a minimum 38.2% of the trend should be retraced before homebuilders have a shot at another burst of outperformance.

So there’s clearly further for these guys to fall.

In my opinion, it’s more likely this ratio could retreat a full 61.8%. This means homebuilder stocks still have plenty of excess steam to let off and they’re likely to underperform the broad market for some time.

Stay clear of homebuilders for now! Their day in the spotlight is fading fast.