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What Do Building Stocks Say On A Housing Recovery?

Investor optimism has lifted stock market rankings of several real estate industry groups, even as housing's rocking-horse recovery tilts between good and discouraging news.

This week the Census Bureau said building products led retail sales up in March with 14% year-over-year growth, as building permits edged up. But housing starts slid, homebuilder industry confidence sagged for a first time in months, and the existing-home sales pace fell 2.6% in March, the National Association of Realtors said. It's up year over year.

"The recovery is spotty," said David Crowe, chief economist with the National Association of Home Builders. "Some housing markets are on the mend.

Although real estate indicators are all over the proverbial map, stock prices for homebuilders and many associated industries have been pounding out steady gains. Among IBD's 197 industry groups, residential and commercial building stocks collectively have lifted 46% off an October low. Building product retailers are up 59% and the mortgage service group 67%.

Most building-related groups list few leading stocks. But gains show institutional investors at work.

The question's who, at this uncertain stage of recovery, is buying

Vanguard's Windsor Fund took on 3.9 million shares of builder Lennar (NYSE:LEN - News) in Q1, and Vinik Asset Management more than 800,000 each of D.R. Horton (NYSE:DHI - News) and Toll Bros. (NYSE:TOL - News) Fidelity Contrafund added 2.9 million of D.R. Horton, for example.

Taking Stock Many analysts think housing has found a bottom. But banks remain overstocked with wobbly mortgages apt to yield more foreclosures. Restricted lending continues to choke the flow of qualified buyers to a dribble. Recent quarterly reports from banks such as Wells Fargo (NYSE:WFC - News) and JPMorgan (NYSE:JPM - News) showed pressure easing, with sharp slowdowns in charge-offs — mortgages and other loans deemed uncollectible.

Cyclical housing theory holds that if banks gain confidence that the market's bottomed, they are apt to ease lending standards, boosting demand. More demand puts more builders to work, lifting wages. The employment gain, some economists argue, spurs more housing demand.

That potential for a rapid, large-scale uptick in sector activity lures a tribe of investors willing to risk the stocks' high betas, says Ed Yardeni, president of Yardeni Research.

"When those stocks move, they can be up 30% in a heartbeat," he said. "But they can also be heartbreakers. It's a volatile game.

Construction of apartments and other multiunit homes jumped 55% in 2011 but has eased since. Single-family building keeps struggling.

Still, the financial outlook among builders offers some support for those who see a recovering market.

After five years of brutal losses and revenue squeezes, analysts expect homebuilder Lennar's earnings to jump 143% this quarter, and for peer NVR (NYSE:NVR - News) to post a 66% gain.

Outside the U.S., Homex (NYSE:HXM - News) is sitting on forecasts for a 92% gain and Gafisa (NYSE:GFA - News) a 275% surge.

Keybanc Capital analyst Kenneth Zener upgraded Lennar to buy April 12, with a 32 price target. Lennar's particularly astute in managing its portfolio of construction lots, Zener says, giving it an advantage when demand starts recovering.

Not all news is of a turnaround. Pulte Group (NYSE:PHM - News) and Ryland Group (NYSE:RYL - News) are forecast for Q1 losses, at far shallower levels than a year ago, like KB Home (NYSE:KBH - News) saw.

Most publicly traded builders operate in national or at least multiregional markets. It's also true of industries such as building products and mortgage services providers.

Regions influenced by energy or agriculture are apt to be doing better than others. Modular home builder Cavco (NASDAQ:CVCO - News) has seen leaps in sales and profit, largely as producers of oil and natural gas in shale-play regions see a sudden need for employee housing in remote areas.

Building's going on, but Crowe says it's mostly in regional markets.

Location, Location Texas has come back stronger than most, Crowe says, owing partly to its energy boom and the fact its market was not as superheated before the crash. Strong regional construction has also helped drive up bank stocks in the Midwest and West/Southwest, lifting those industry groups into the top ranks.

The housing bust hit hardest in some of the biggest and busiest markets, such as in California and Florida, dragging down building data.

"They are a long way from recovering," Crowe said, so the numbers "don't look as strong nationally.

Building products retailers such as Home Depot (NYSE:HD - News) and Lowe's (NYSE:LOW - News) cast a broad net. Like builders, they benefit as construction recovers. They also tap homeowners doing remodels put off in a shaky economy.

Farm and ranch store operator Tractor Supply (NASDAQ:TSCO - News) has also benefited from those trends. Its stores are in areas driven by agriculture, which snapped back early from the recession to a record-setting boom.

Another sector basking in an early building activity upturn: equipment rental stocks. United Rentals (NYSE:URI - News) and RSC Holdings (NYSE:RRR - News) (which are in a $1.9 billion merger) have seen financial and stock performance rebound abruptly, alongside recovering construction gear demand. The stocks are generally seen as early plays in the housing cycle, as contractors do more work, but hesitate to buy equipment.

The timetable for a housing recovery remains far from certain. Yardeni says data will tell the tale. Without further encouragement, institutional investors speculating in the stocks may be set to take profits.

"They tend to rent them, not to own them," Yardeni said. "They are looking for that quick 30% pop, and you have that already."