This Story Doesn’t End Well for Housing: Higher Mortgage Rates, Slower Demand

[TradeSmith Daily]( This Story Doesn’t End Well for Housing: Higher Mortgage Rates, Slower Demand When you’re a kid, there’s no greater angst-triggering moment than when your parents come to you and say: “We have to move.” Growing up in a troubled suburb of Baltimore, my sister and I experienced that angst personally — after my folks had their hand forced by several scary incidents in and around our neighborhood. The first of those incidents was when the family car was broken into — windows were smashed and stuff taken — while it was parked in our driveway right outside our front door. The second, and the real clincher, came when my sister got home from school, was asked how her day was, and reported seeing her first gun. In middle school. We ended up moving from that marginal suburb and into a more upscale spot called Owings Mills. I was well into my adult years when I finally understood what a risk my mom and dad had taken on and the sacrifices they’d made for us two kids. The reality was that my parents really couldn’t afford this move. Houses were much more costly in Owings Mills than in our previous neighborhood. And market interest rates were up around 13%. That meant my parents took on a massive amount of debt — just to keep their son and daughter a little bit safer. But in true parent fashion, they made it work. They were aggressive about paying down the mortgage. And whenever rates ticked down a bit, they refinanced. Those two strategies — with a splash of aggressive frugality mixed in — meant we were able to afford the “unaffordable” and pay down the debt as fast as possible. Eventually, my parents owned that house free and clear. And they gifted my sister and me an important lesson on the value of a high-savings/low-debt lifestyle. It’s a lesson I live by at home (I see it as being “smart and frugal” when I order water and skip big-ticket appetizers at restaurants, though I know my family and friends like to refer to me as a “cheapskate” — affectionately, of course). And frugality is a consistent mantra here. This childhood story jumped to my mind this past week as the recent Federal Reserve rate hike triggered a mushroom-cloud increase in mortgage rates. And now that lending rates on housing have skyrocketed, it’s time to examine the fallout. RECOMMENDED LINK [Bezos, Zuckerberg, Cuban, and Gates are in, are you?]( A groundbreaking new $30 trillion shock wave is taking the crypto world by storm... And all the smart money is moving ahead of [this]( upcoming shock. The world’s smartest Billionaire investors like Jeff Bezos... Mark Zuckerberg... Mark Cuban... Bill Gates... are all moving their money as we speak. JP Morgan, the largest bank in the U.S., just made its move to prepare itself for this upcoming shock – so did Wells Fargo and Goldman Sachs. But the real story is the tiny $2 crypto situated at the forefront of this $30 trillion wave. Forbes even went as far as saying that the tech behind this class of coins is going to change your life. [Click here to see the $2 coin leading the way]( Housing Supply and Demand Like any asset, home values are a function of supply and demand. When demand exceeds supply, prices rise, and vice versa. And right now, demand in the housing market far outpaces supply. The Federal Reserve is doing what it can to clamp down on demand. Since the majority of homes are bought on credit through mortgages, higher interest rates make homes less affordable. Already, we’re seeing signs that housing demand is starting to slow. Last month’s new home sales data showed the pace of new residential sales falling back in line with historical trends. U.S. Census Bureau Similarly, existing home sales dropped back down to historical averages. National Association of Realtors Despite all this, home prices continue to climb because inventory remains scarce. And the Fed can’t do anything to stimulate construction, especially when it’s constrained by supply chain challenges. That means the Fed can only continue to increase the cost of home ownership and drop demand far enough that supply can catch up, even at its languid pace. Profit From the Plunge Given this outlook, I see several possible outcomes: - Interest rates could continue to go higher. - Mortgage demand will plunge. - Homebuilders will neither sell more nor continue to realize higher sales prices. Let’s look at what this means for investments. Turning to mortgages, we know that some banks, such as Wells Fargo & Co. (WFC), get a larger percentage of their revenues from home loan origination than others. There are also companies (like Rocket Companies Inc. [RKT], parent company of Rocket Mortgages) with subsidiaries whose sole purpose is to offer mortgages. In either case, I would want to steer clear of them as stock positions, but they may make good trades for out-of-the-money [call credit spreads, which can be used for income-seeking investors](. Call credit spreads are options strategies where you sell a call option at a strike price above the stock’s current price and buy another call option at a higher strike price for the same expiration. The trade pays you a net credit, which you keep no matter what. Your goal is to have the stock finish at or below the lower strike price at expiration, rendering both option contracts worthless and allowing you to keep the credit you received to initiate the trade. This also is a great strategy to use on homebuilder stocks, which have been in a steep sell-off for several months now. Here’s how you might do it on D.R. Horton Inc. (DHI), a home construction company. Take a look at the weekly chart below. TradeSmith Finance Just before the end of 2021, DHI topped out just above $108. Since then, it’s dropped just below $60. That rapid and severe decline pushed the stock into the Health Indicator Red Zone. If I expect home sales to get even worse, I could use rallies in the stock to initiate call credit spreads at key resistance levels. Looking at the chart, I identified two important price levels: $77 and $90. TradeSmith Finance Using these as my guideposts, if the stock were to rally back toward $77, I would sell a call option with a strike above $77, say $80, and then buy another at a higher strike, like $81, depending on how much I wanted to risk. From there, I might choose an expiration anywhere from two weeks to two months away. I could continue to repeat this trade as long as the overall momentum remained weak and I expected home sales to decline. 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Horton today, but there are many suppliers and ancillary players that are likely to take a hit as well. What other companies related to the housing industry would you like me to analyze? [Email me your thoughts](mailto:keith@tradesmithdaily.com). [Keith Kaplan]Keith Kaplan CEO, TradeSmith P.S. Could an extra $2,880 help with your monthly mortgage debt load? Because I’ve discovered an investing hack that unlocks a secret cash corner of the stock market. Just play this 60-second trade for immediate cash every time you pull the trigger. [Click here]( for a one-minute demo. Best of TradeSmith The chart below represents the best-performing open positions over the last two years, as recommended by our software. [Download now on the Apple Store]( [Get It On Google Play]( [866.385.2076](tel:+866-385-2076) | support@tradesmith.com ©TradeSmith, LLC. All Rights Reserved. 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