The week ahead is pretty light on economic reports, but there are a few that will be closely watched. A number of the reports that are due out involve the housing industry. We are scheduled to see six different housing industry reports during the week including housing starts and existing home sales for May. Of the reports that have analyst predictions, all are expected to show increases over the previous levels.
It is interesting to see that all of the housing industry reports are expected to show improvement over the last reports. Housing is one of the most interest rate sensitive industries and we are in a rising-rate environment. Housing starts have actually been on a steady rise since late 2010 and rising interest rates have done little to slow down the momentum over the last few years.
The 10-year Treasury is the key interest rate that most mortgage companies base their interest rates off of, and we have seen the yield on the 10-year climb from a low of 1.33% in mid-2016 to a recent high of 3.12%.
At some point, the rising interest rates will have an impact on the housing industry. What and when that point is are unclear at this time. I wrote an article back in February and pondered that a rise of two percent on the 10-year could be a key inflection point where rates have jumped too much and have a negative impact on the economy and stock market. In the current case, that would mean that the 10-year yield had reached 3.33%. Could that be the key point for the housing industry as well?
It is somewhat of a catch-22 to want the 10-year rate to stop rising because if it does stop its upward trend, the 2-year yield could move above it and create an inverted yield curve. And an inverted yield curve has never been a good sign for the economy. With the Fed signaling two more rate hikes for 2018, the odds of the 2-year and 10-year becoming inverted increased.
The expansion in the economy is already one of the longest in history and the housing market has been a big beneficiary. Looking at the SPDR S&P Homebuilders ETF (NYSE: XHB), we see that the fund has gained over 450% since the low in March 2009 and that is just slightly better than the S&P 500 SPDRs (NYSE: SPY).
I wouldn’t start selling homebuilder stocks just yet, but there is going to come a point where the housing reports aren’t increasing the way they have for the last nine years. There are three things that I would keep an eye on as a signal to get out of homebuilders. First, when these reports—housing starts, existing home sales, etc., start showing any kind of weakness. Secondly, if the 10-year rises above 3.33% I would look to get out of any homebuilder stocks I was holding. The third one would be if the yield curve becomes inverted.
Any or all of those scenarios will cause a selloff in housing stocks and will likely take the XHB down by at least 25% if not more. The financial crisis in 2007-2008 caused the XHB to drop almost 80%. I don’t think we see that kind of drop, but I wouldn’t want to take any chances either.