Sometimes You Shouldn't Bet Against the Crowd

You don't have to look hard to find losers this year...

Tech stocks have gotten wrecked. Bonds are enduring one of their worst crashes in history. And the overall market saw its first correction in years.

One of the biggest losers of 2022 was an incredible winner last year. The sector jumped 49% in 2021. But it's down 29% so far this year... giving back all those gains.

I'm talking about homebuilders. As the losses in this sector pile up, investors are heading for the exits. That often signals a contrarian opportunity. But in this case, you don't want to bet against the crowd.

Let me explain...

Homebuilders are notoriously volatile. The crash that has followed last year's huge gain perfectly illustrates why they've earned this reputation.

Investors don't have the stomach for it, though. They're jumping out of the sector at record pace...

Specifically, shares outstanding for the iShares U.S. Home Construction Fund (ITB) fell more in a recent three-month stretch than at any other time in the past decade. That tells us investors are pulling money out of the fund...

That's because exchange-traded funds like ITB can create and liquidate shares based on demand. If investors flood into the fund, ITB can create new shares. But if they sell in droves, the fund will liquidate unnecessary shares.

That makes the total share count a rough barometer for investor interest. And again, folks have been fleeing the fund like crazy this year. Take a look...

ITB's overall share count is near pandemic lows. But it's not the level we're interested in today... It's how quickly we got here.

You can see that shares outstanding peaked at the start of the year. They then plummeted 30% in just three months. That's the sharpest three-month fall ITB's shares outstanding have ever seen.

Simply put, investors haven't rushed out of homebuilders this quickly at any other time over the past decade. That might seem like we have a contrarian opportunity... But history disagrees.

To check, I looked at every instance where shares outstanding fell by 25% or more within three months. That still only happened 3% of the time.

Those setups didn't lead to big gains, though. Instead, the losses continued to pile up. Take a look...

Homebuilders are volatile. But they've also led to fantastic gains over the past decade – up 14.5% per year over that period.

You'd expect even better returns as investors flood out of the sector. But you'd be wrong... Similar setups have led to 8.5% losses in three months, 11.7% losses in six months, and a 2.3% loss over the following year.

This isn't normal. We'd usually view this kind of setup as an opportunity. But clearly, it's not a contrarian buy signal.

Combine that with the recent downtrend, and homebuilders are a sector to pass on right now. History says they'll bounce back strong at some point. But we're not there yet.

Good investing,

Brett Eversole

Further Reading

"Buying when shares are still falling is a dangerous game to play," Chris Igou writes. When a fund's prices crash, it can be a good sign of a contrarian opportunity. But history shows you need two other ingredients on your side... Read more here: Sentiment Is Dangerously High in One Falling Market.

As contrarian investors, we're always searching for cheap, hated assets. That means when the crowd is making a move en masse, we normally do the opposite. We recently highlighted one market to avoid today... Learn more here.

Market Notes
THIS COMPANY IS STILL FEELING THE PRESSURES OF THE 'RETAIL APOCOLYPSE'

Today’s chart shows another victim of the retail “death spiral”…

Regular readers know times have been tough for brick-and-mortar stores. The COVID-19 pandemic has accelerated the long-term e-commerce trend… And many companies that came late to the online-shopping wave have been left behind. Today’s home-goods retailer is struggling to keep up…

Bed Bath & Beyond (BBBY) has suffered from online competition for years. Then, during the pandemic, folks who were stuck at home turned to the store for do-it-yourself projects and redecorating jobs. But with recent global supply-chain issues, the retailer has had a hard time keeping its shelves stocked… which has forced it to close some of its locations. And these new challenges have weighed heavily on the company… In its most recent quarter, Bed Bath & Beyond’s sales declined 22% to $2.1 billion.

As you can see, shares of BBBY are in a downtrend. They’re down roughly 55% over the past year, and they recently hit a new 52-week low. As traditional retailers continue to struggle, many stores like Bed Bath & Beyond will see their shares slide…