Though banks will put more homes on the market as they sort out the foreclosure process, economists think the era of too many unsold homes chasing too few buyers has passed.

Indeed, just as supply is dropping, demand should finally start to percolate as 200,000 more Americans find employment every month. "We cannot hope to have a robust housing market in the absence of vibrant employment," note analysts at UBS in a recent report.

Cautious Optimism
Companies that build new homes are watching closely as they lay out their own construction plans. They've managed to keep a tight lid on supply, with less than six months' worth of inventory-down from 12.1 months in 2009-and are expected to slowly ramp up construction activity in coming quarters. They've got a lot of catching up to do.

Home builders constructed between 500,000 to 600,000 new homes in each of the past three years, which is the lowest three-year period on record (the data go back to 1959). And it's just half the average rate seen during the past 40 years.

Meanwhile, thanks to natural population growth, new household formation averages around one million every year. In a more stable economy, you can expect homebuilders to pour foundations for roughly one million new homes every year just to meet the demands of a growing population.

The industry sentiment has clearly changed, what with builder confidence at five-year highs, notes S&P/Capital IQ's Souers. And he adds the sharp drop in home prices and current low interest rates has pushed home affordability to record levels. According to Credit Suisse, the house price-to-income ratio is now 7% lower than the pre-bubble (1985-2000) average.

But Souers thinks it's too soon to give housing stocks a thumbs up because he eyes a modest industry recovery and believes home building stocks might have gotten ahead of themselves during the recent rally that saw the S&P 500 Homebuilding Subindustry Index more than double from early November through late March. Since then, the index has slid more than 8% through April 5.

He also thinks that the supply of homes for sale may increase after home prices rise as the most stressed homeowners finally get a reprieve from being "underwater," and put their homes on the market. "It could take several years to work off this shadow inventory," he says, before adding that "homebuilders are now in far healthier shape and leveraged to even a moderate upturn."

Cautious optimism might be the operative phrase regarding the housing market, but by the time people are strongly optimistic, housing stocks and ETFs that track the industry will likely have already had their bull run.