Financials Fear Rising Rates As Housing Market Weakens

Financials Fear - Stocks Weak Again On Monday

The S&P 500 fell 0.43% as it was dragged down by the financials. Nasdaq rallied 0.26% as tech outperformed. Russell 2000 fell 0.16%. Because Russell 2000 firms have a large percentage of their debt in floating rate bonds, rising rates hurt this index.

CNN fear and greed index went up from 14 to 16 even though stocks fell. VIX went down 1.26% to 19.64 even though stocks fell. Both of those aren’t sustainable trends if stocks continue to fall.

Financials Fear - Explanation Of The Extreme Fear Reading

The extreme fear reading from the CNN index makes me bullish on the short term. I’ll break down the components of the index. Junk bond demand, which is the spread between junk bond yields and investment grade yields, signals greed.

Volatility, which is the VIX and its 50 day moving average, is neutral (explaining the index’s increase to 16). Market momentum, which is the S&P 500 and its 125 day moving average, signals extreme fear.

Stock price strength, which is the net new 52 week highs and lows on the NYSE, signals extreme fear. This is signaling a much worse reading than during the winter correction as you can see in the chart below.

Safe have demand, which is the difference between 20 day stock and bond returns, is signaling extreme fear. Stock price breadth, which is the McClellan volume summation index, signals extreme fear.

This index measures the advancing and declining volume on the NYSE. Finally, the 5 day average put/call ratio signals extreme fear. As you can tell, the main component keeping this away from 0 is junk bond demand. This selloff in equities hasn’t spread to other risk assets.

Financials Fear - Bank Stocks Crater

Every sector fell except technology and consumer discretionary. It’s very rare to see these risky sectors up on a down day. They increased 0.81% and 0.48%.

So far, Netflix is the only member of the FAANG stocks to report earnings. Amazon and Alphabet report Thursday and Microsoft reports Wednesday. I’ll be covering those reports. The worst sectors were real estate and the financials which fell 1.42% and 2.06%.

As you can see from the chart below, the 5 day RSI of the bank stocks is the lowest in over 20 years. That means it’s worse than during the financial crisis.

It’s amazing that even the bank stocks are fearing rising rates. The KBE small bank ETF fell 2.8%. Bank of America and Citigroup fell 3.32% and 3.3%.

The fear is higher interest rates will hurt mortgage loan growth. I think we’re on the brink of a housing decline. It’s not going to be like the last crisis, but low affordability combined with rising rates is a recipe for weakness.

Financials Fear - Weak Housing Market

The home builder ETF XHB is in complete freefall as it fell 1.07% on Monday. Amazingly the index is down 15.54% in the past month. It’s down 28.83% since January 22nd.

Consumers think housing is the most unaffordable since 2008. As you can see from the chart below, home prices have been growing quicker than incomes for the past 6 years.

JP Morgan believes home price growth is going to slow to 3.3% in 2019. If income growth slows, it will be even worse for housing. Personally, I think income growth will be strong because of the tight labor market. But the possibility needs to be mentioned.

If interest rates increase further, home price growth will be lower. The 30 year fixed mortgage rate is 4.85%. It was 3.88% last year. Yields didn’t increase much on Monday. The 2 year yield increased 1 basis point to 2.91%. And the 10 year increased 1 basis point to 3.2%.

The difference between the two yields is still 29 basis points. 2 year yield is at a cycle high and the 10 year yield is still below its early October high of 3.26%.

Financials Fear - Weak Housing Starts

September housing starts last Wednesday missed estimates. They came in at 1.201 million which missed the consensus for 1.216 million. And they fell 5.3% from last month.

Completions fell 4.3% to 1.162 million which is the lowest since November 2017. Keep in mind, you can compare data from each month because this is the seasonally adjusted annual run rate.

August stats were revised lower from 1.282 million to 1.268 million.

As you can see from the chart below, the 5 month moving average has been declining since early in the year. Housing starts were hurt by hurricane Florence as they fell 13.7% in the south. However, they also fell 14% in the Midwest which wasn’t affected by the hurricane.

Building permits were 1.241 million which missed estimates for 1.272 million. It was the weakest report since November 2017. August’s report was revised upwards to 1.249 million from 1.229 million.

That means they fell 0.6% from August to September. Multi-family permits were down 7.6% and single family permits were up 2.9%. Permits fell 1% year over year. They fell 7.8% for multi-family and rose 2.4% for single family homes.

Financials Fear - Weak Mortgage Applications

Weak mortgage applications index supports the notion that banks could see weak loan performance in Q4. MBA mortgage applications composite index fell 7.1% in the week of October 12th. That’s on top of the 1.7% decline the prior week.

It’s no surprise that refinances were down. They fell 9% on top of a 3% decline. However, the purchase index was also weak as it fell 6% on top of a 1% decline.

Financials Fear - Conclusion

The housing market is starting to dominate the narrative as rising rates are now considered a bad thing.

If the housing market continues to weaken, it will hurt the consumer.

Weak existing home sales, MBA mortgage applications, and housing starts have catalyzed a crash in the home builder ETF.

If the financials follow them lower, it’s bad for the market. I’m still bullish on the S&P 500 for next month, but I’m becoming increasingly bearish on the next year.

 

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