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Homebuilder Stocks May Have Further Room to Run

Homebuilders have been on a stellar six-month run, with the S&P homebuilder index surging almost 80 percent since mid-September, and some analysts expect the rally to continue.

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Drywall

“We’re expecting to see continued improvement [in housing]…the trend is obviously in place," said Joe Bell, senior equity analyst at Schaeffer's Investment Research.

Other analysts shared Bell's view. Earlier this month, Credit Suisse upgraded a number of builders including D.R. Horton , Lennar and Toll Brothers to "outperform" from "neutral," citing improving trends in the housing market and increasing buyer traffic.

Credit Suisse also upgraded Meritage and Ryland to “neutral” from “underperform.”

Despite the strong performance in homebuilders, it's important to note that the index is still down almost 50 percent from its all-time high in April 2006. Meanwhile, some skeptics have been hesitant to jump in amid the volatile housing market, including rising rates.

“Rising rates are not a concern yet,” explained Megan McGrath, homebuilder analyst at MKM Partners. “Affordability is still near an all-time high—it’s the tightness and availability of credit that’s the problem.”

McGrath added that housing remains on the forefront for both the Federal Reserve and the Obama administration.

“It also helps that it’s an election year—if we see slippage, the Fed is motivated to act and keep the wheels greased in terms of what it can do on the rates.”

While housing reports this year have generally pointed to an improving recovery in the real estate market, growth remains at an anemic pace.

In the latest sign, home builder sentiment remained unchanged in March, while February’s reading was revised down, according to the National Association of Home Builders/Wells Fargo Housing Market Index.

Most major homebuilders dipped into negative territory following the news.

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Today's housing report is the first installment in a handful of housing releases, expected this week. Investors will get data on housing starts and building permits on Tuesday, existing home sales and mortgage applications on Wednesday, FHFA home price index on Thursday and new home sales on Friday. Also, KBHome is scheduled to post earnings at the end of the week.

McGrath said while it's wise to invest in homebuilders during a housing recovery, she prefers to own them “a little cheaper.”

“Take days like this and start to build your position slowly on days when stocks are going down,” she suggested. “It’s not going to be a linear recovery.”

In particular, McGrath says she prefers luxury builders such as Toll Brothers and Pulte, adding that the New York and New Jersey areas have been beneficial for the two companies. She has “buy” ratings on both stocks.

Follow JeeYeon Park on Twitter: @JeeYeonParkCNBC

Questions? Comments? Email us at marketinsider@cnbc.com

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