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Stock Watch List - Countrywide Financial Corp. (CFC)

(October 21, 2004)

Dear readers, please note that we will only be publishing an abbreviated commentary this weekend and no commentary next Thursday morning as I am currently utilizing most of my time to study for an actuarial exam set for next Friday.  I will stick to my word unless something unforeseen and important happens in the stock market!

Again, readers are encouraged to exchange ideas and views on both our individual “stock picks” and our market commentaries.  Please start posting in our Discussion Forum today!

We last discussed Countrywide Financial (ticker symbol CFC) in our June 29th individual stock watch commentary.  At that time, I stated that CFC (the stock) may be on its last legs – given the gap down the day before (on an earnings warning from Washington Mutual) and given the fact that I thought the housing bubble (in some parts of this country) may be on its last legs.

That statement turned out to be four months early (of course, both you and I know that four months is an eternity in today’s markets) but I hope that some of my readers have heeded the warning and at least took a hard look at CFC if they had a position in that stock.  CFC had been a hedge fund and IBD-momentum favorite stock for the last two years (it has been consistently ranked number one by IBD out of all the stocks in the mortgage financing/real estate services industry), as can be seen from the following five-year chart:

Countrywide Financial Corp. (CFC)

Please note the favorable action even during the events of September 11th and the bear market that we went through during 2001 to 2002.  It is no coincidence that the stock started taking off and became a hedge fund favorite stock starting in March 2003.

CFC had a huge gap down yesterday and proceeded to shed over 11% in value in one day on lackluster earnings – primarily in its mortgage refinancing business (surprise, surprise).  The stock closed at $33.17 today – approximately 5% lower than when I first “warned” about the prospects of the stock.

Yesterday’s gap down was ominous; as it represented the largest gap down I have seen for the stock (suggesting a high possibility of a change in trend).  Moreover, the stock is now flirting with its 200-day/40-week moving average – a level which it had not broken since October 2002 and ever since this huge two-year uptrend began!  Such a decisive break would be even more ominous, as can be seen in the following daily and weekly charts:

Countrywide Financial Corp. (CFC) - The gap down that I discussed in my June 29th commentary turned out to be a false signal. But the next gap down didn't - and the current gap down should hold even more authority.

Note the huge gap down yesterday on the above daily chart on eight times its average daily trading volume over the last three months.  This is a major break – and this break would be further confirmed if the stock closes below its 200 DMA/40 WMA.  The gravity of such an event is obvious once readers take a look at the following weekly chart:

Countrywide Financial Corp. (CFC) - Also note that the PPO has made lower highs since November 2003 - an early sign of potential weakness. Please note that the 40-week moving average has acted as a huge support level for CFC during the last two years (circled).  Any break below this would carry very bearish implications.

Please note that besides the threat of the stock breaking below its 40-week moving average, there is also a threat of the relative strength of the stock (vs. the S&P 500) breaking below its 20-week exponential moving average – again, something which it has not done since this two-year uptrend began.  Also, the weekly PPO has been making lower highs for the last 12 months – suggesting that the upside momentum in the stock has been weakening over the last year.

Readers who have kept track of my commentaries and of my postings in our discussion forum should know that I have been looking for a top in homebuilding stocks and in mortgage financing stocks in general for the last few months.  The initial warning came two weeks ago when Pulte Homes announced a major cut in new home prices in the Las Vegas market, and subsequently warned that third-quarter and full-year earnings would be below expectations – driving down the homebuilders as a group even as Toll Brothers, D.R. Holton, and MDC Holdings tried to soothe the market by subsequently coming out with relatively optimistic outlooks.  Then there is the falling price of lumber – following is a daily chart of the November contract updated as of last night:

Lumber November contract

While lumber prices rebounded somewhat yesterday, the 25% decline in lumber prices over the last six weeks signals further signs of a slowdown in the homebuilding industry.  In my humble opinion, today’s announcement by CFC definitely puts the final nail in the coffin, so to speak.  Astute traders would probably do well by periodically trading the stock (and homebuilding stocks in general) on the short side over the next few years.

Happy Trading/Investing!

Henry To, CFA

P.S. Please discuss this stock in our individual stocks discussion forum.

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