Investors soothed by the stock market rebound should not get too comfortable in U.S. homebuilder shares. Last week's sell-off in that sector was no mere blip triggered by unrest on Greek streets far from placid U.S. suburbs.

Rather, it's a sign of things to come despite the current surge. The sector's shares are up 20 pct year to date as measured by the Dow Jones U.S. Home Construction Index .DJUSHB compared with a 3 percent rise for the Standard & Poor's 500 index .SPX.

Housing stocks fell 5 percent last week in a general sell-off triggered by anxiety over the Greek debt crisis.

If you look at the data we've seen so far, we're in a choppy period, far more so than the builder valuations would suggest, said UBS analyst David Goldberg.

But the spike rests on the wobbly foundation of government support. The rally kicked into high gear on April 23 after the Commerce Department said sales of new homes jumped 26.9 percent in March as buyers rushed to take advantage of a federal tax credit of up to $8,000 for purchases closed by April 30.

Investors pinning hopes for homebuilder stocks on that number are making a mistake, said John Burns, whose real estate consulting firm is based in Irvine, California.

People who don't know the industry are overreacting to (March's) new home sales number, which is still one of the worst months of all time, Burns said.

Now that the homebuyer tax credit has expired, a few turbulent months will likely hit builder shares.

But those who can stomach it should be rewarded in the long-term as competitive advantages emerge in a sector where every builder shrank to survive the downturn.

A SOFTER SECOND HALF

The federal tax credit induced homebuyers to expedite their purchases, but did not create new customers. That means a lull in demand will hit builders in the second half of the year, Credit Suisse analyst Dan Oppenheim wrote in a client note.

Homebuilders also face rising mortgage rates, which make new homes less affordable; price pressure from foreclosures and short sales and higher lumber costs, according to research from Raymond James analysts Buck Horne and Paul Puryear.

Accordingly, they downgraded MDC Holdings to outperform from strong buy, and Lennar and The Ryland Group to market perform from outperform.

Disappointing second-quarter order and income numbers could also create volatility in the share prices.

Investors may not realize that some builders' second-quarter orders, such as MDC Holdings' and Standard Pacific Corp's, will likely be down due to the tax credit expiration, J.P. Morgan analyst Michael Rehaut wrote.

Ryland and MDC Holdings are expected to miss analysts' targets in their next quarterly financial reports, according to Starmine's SmartEstimate, which places more weight on recent forecasts by top-rated analysts instead of using a general average.

HOLD STEADY?

Investors with a longer view should see the market's near-term turmoil as a buying opportunity, said UBS' Goldberg.

There's something to be said about headwinds in the housing industry as you look out three or four months, he said. The stocks aren't incorporating those. Catalysts are going to be to the downside. We'd look at pullback as an opportunity get more constructive on the stocks.

Mutual funds are creeping back into homebuilder stocks, said Conifer Securities trader Brian Daley.

We're patient investors. We're constantly looking for areas where we think there's an inordinate amount of pessimism, said Thomas Villalta of Jones Villalta Funds, which owns shares of luxury builder Toll Brothers Inc.

He expects to see a potential profit from his position by the end of 2010.

Like other builders, Toll will benefit from increased demand as the children of Baby Boomers form families and buy homes. But as a luxury builder, Toll's relatively high pricing makes it a safer play, Villalta said.

Toll is also Goldberg's top pick for its impressive liquidity and opportunity to gain market share, and J.P. Morgan's Rehaut has an overweight rating on the shares.

Rehaut likes KB Home as well, as do Horne and Puryear of Raymond James, who said buyers like the company's Open Series of smaller and more flexible floorplans, which should help it gain market share.

And of course, there's always Pulte, which became the biggest of the bunch after buying Centex in 2009. Its size is a strength, said Eric Marshall, director of research for Hodges Capital Management, whose Contrarian Fund holds Pulte shares.

We see Pulte as being a survivor, Marshall said. Combining with Centex gives them the staying power to be well-positioned once things do fully turn around. We recognize that may take some time.

(Reporting by Helen Chernikoff; Editing by Richard Chang)

California Investment