Fed President Bostic wants to hold rates steady all year … the related impact on mortgage rates … why homebuilding stocks are surging today … checking in on our ITB trade
Frustrated would-be homebuyers just suffered another “eye-roll” moment…On Tuesday, Atlanta Federal Reserve President Raphael Bostic said he envisions one last rate-hike, followed by a long pause, with rates held at that elevated level.Translation – mortgage rates are poised to keep housing affordability beyond the reach of millions of Americans.Here’s what Bostic actually said:
One more move should be enough for us to then take a step back and see how our policy is flowing through the economy, to understand the extent to which inflation is returning back to our target.If the data come in as I expect, we will be able to hold there for quite some time.Once we get to that point, I don’t have us really doing anything but monitoring the economy for the rest of this year and into 2024.
To be clear, mortgage rates aren’t officially tied to the Fed Funds rate. But practically speaking, they mirror the Fed’s decisions.To illustrate, below, we look at the Effective Fed Funds rate (solid black line) and the average 30-year fixed mortgage rate (dotted black line) over the last decade.As you can see, though mortgage rates oscillate, it’s clear they track the Fed Funds rate.
Yesterday, we learned that mortgage demand crumpled 10% last week as rates jumped again
Let’s go to Bloomberg:
Today’s homebuyers appear to be increasingly sensitive to weekly moves in mortgage rates. While home prices are easing some, affordability is still a major hurdle, especially as more first-time buyers enter the market.Last week, the average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($726,200 or less) increased to 6.43% from 6.30% the previous week, with points rising to 0.63 from 0.55 (including the origination fee) for loans with a 20% down payment.As a result, mortgage applications to purchase a home dropped 10% from the week before, according to the Mortgage Bankers Association’s seasonally adjusted index.
But if you think the recent mortgage-rate environment has been bad for homebuilder stocks, think again.We’ll show you the market performance momentarily. But let’s begin with why you’re about to see gains.From Bloomberg:
In a US housing market warped by sharply higher interest rates, homebuilders possess what buyers crave: inventory……Buyers have begun flocking to builders’ sales offices, where offers of discounts and rate buy-downs are so generous that it’s often cheaper to buy new than pre-owned.Traditional sellers, meanwhile, have become a rarity, as few homeowners are willing to move and relinquish their lower-rate loans. And with new listings on the decline, buyers are tired of just sifting through scraps.
It’s an interesting dynamic – there’s already a housing shortage. Now, add to that the reality that existing homeowners who are sitting on historically-low mortgage rates from a couple years ago are simply not selling.They’re looking at today’s market, saying, “sure, I can list my home for a lot more money, but then I’d have to pay a lot more to buy a new place, so that’s a wash. Plus, my new mortgage-rate would be through the nose. Net-net, this would be a loss, so I’m going to do nothing.”This refusal to list limits housing inventory even further…which translates into a massive tailwind for homebuilders who are creating product.Back to Bloomberg with some statistics:
Just as the key spring selling season was getting started, purchases of previously owned homes tumbled nearly 25% last month compared with the previous March, a Redfin analysis shows.At the same time, new-home sales increased 5.6%.
And if we look at a longer-term chart of the percentage that new homes make up of all available single-family homes in the U.S., the growth is significant.As you can see below, in February 2020, the number clocked in at 20.3%. As of February 2023, it had climbed to 33.4%.
This 1/3rd proportion of new homes on the market represents more than double normal levels.
As to how homebuilder stocks have been faring, let’s check in with our ITB trade which we introduced exactly one year ago today
In our April 20, 2022, Digest, we suggested that aggressive investors could jump into an iShares Home Construction ETF (ITB) trade. ITB holds homebuilding heavyweights including DR Horton, Lennar, NVR, Pulte, and Toll Brothers.Our trade suggestion was due to the potential for major, multi-year gains we see coming after the market bottomed from recent basement prices.Here was our disclaimer from that Digest about our timing and the potential for further volatility:
If you’re an aggressive trader who doesn’t mind the possibility of being early and sitting through some sideways (or even down) action, this is a reasonable entry point.
Reviewing this trade now, it was indeed a reasonable entry point.Below, you can see ITB falling further after our April Digest as we warned, but then rallying hard.An aggressive trader who took this ITB position would be up nearly 28% right now, crushing the S&P which is down 7% over the same period.
If you jumped into ITB, congrats on your gains.If we are able to skirt a recession, there’s likely plenty more gains to come for homebuilding stocks – even more so if Bostic is wrong and the Fed begins cutting rates later this year.
But if you’re considering ITB today, keep an eye on its Relative Strength Index (RSI) level
RSI is a momentum indicator that measures the extent to which an asset is overbought or oversold. A reading over 70 suggests an asset is “overbought” (which increases the odds of a mean-reversion pull-back) while a reading below 30 means it’s “oversold” (which increases the odds of mean-reversion gains).Traders often reference a stock’s RSI as a way to help time entries and exits.As you can see below, right now, ITB’s RSI has just surged into overbought levels, coming in at nearly 75 as I write Thursday. The last time that ITB pushed past 70 into overbought territory, the ETF quickly reversed, dropping from about $73 to roughly $66.
Now, this overbought RSI doesn’t mean that ITB has to pull back immediately. Bullish investors can push an asset deep into extreme RSI levels (whether bullish or bearish) when the mood strikes.But it does mean that the more “stretched” ITB’s RSI becomes, the greater the likelihood of a mean-reversion selloff.Watch for a divergence between the RSI and ITB’s market price. Specifically, if you see the RSI begin to drop even as ITB’s price continues to grind higher, that’s a clue that the bullishness is running out of steam and a price-correction is likely coming.We’ll keep an eye on this and will update you.Have a good evening,
Jeff Remsburg
