Investors have officially thrown in the towel…

The bad news for the housing market has become too much to bear. With soaring mortgage rates, falling sales, and fears of a broader recession… a bust mirroring the great financial crisis seems inevitable.

So, unsurprisingly, the companies building those houses have fallen out of favor with investors. In fact, the combined shares outstanding of the two major homebuilder exchange-traded funds (“ETFs”) are near their lowest level on record.

But that hugely bearish sentiment is actually a good thing for us as contrarians. In fact, the sector could soon take off for a 50% rally.

Let me explain…

The best sentiment signals always show up in what’s happening with real money. People have a habit of saying one thing and doing another. But if they’re selling in droves, you know they want out.

That’s what we’re seeing in homebuilder stocks right now.

Again, we can see this in the shares outstanding for the sector’s two largest ETFs. I’m talking about the iShares U.S. Home Construction Fund (ITB) and the SPDR S&P Homebuilders Fund (XHB).

As ETFs, these funds can create and liquidate shares based on demand. So a falling share count means investors are selling.

These two funds also tend to be similar in size. That means combining their overall shares outstanding gives us a more complete look at the overall sentiment for homebuilders.

The chart below shows ITB and XHB’s total shares outstanding since 2010. As you can see, we’re nearing the all-time pandemic low right now…

Sentiment crashed this year… Shares outstanding for these two funds fell nearly 50% from their January peak.

Also, check out the multiyear lows (green circles) on the chart. They show when investor pessimism has reached maximum levels. That’s where we are today.

As we’d expect as contrarians, though, homebuilder stocks did darn well after times like these. Take a look…

Since these two funds see similar performance, I used ITB to test these numbers. This fund has already been a fantastic winner since 2010, rising 16.7% per year.

Homebuilders are a boom-and-bust sector, though… And buying at a sentiment bottom means you’re buying before the next boom phase.

In this case, it can lead to incredible outperformance. ITB soared 32.6% in the six months after these kinds of setups. And it surged an incredible 50.3% over the next year.

Of course, homebuilder stocks could still get more hated from here. And it’s impossible to know if we’re at the bottom in real time. That’s why we always wait for the trend before buying.

Once the trend turns around and prices start moving higher, we’ll know the sentiment bottom is likely in… And from there, huge gains could follow. That’s why we’ll be watching this sector closely in the weeks ahead.

Good investing,

Brett Eversole

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Source: Daily Wealth