Hedge Fund Bet Turns Sour As Retail Recovers

Bloomberg reports that shorting the CDS index composed mostly of retail mortgages has posted a +8% gain this year, causing pain for hedge funds who took the short side of the trade. These indexes have been rising together with the SPDR S&P Retail ETF (XRT), which is at an important support level:

Source: Bloomberg

These hedge funds would love to see XRT broke this trendline, taking the two CDS indexes with it.

Disclosure: We don’t have any positions in XRT.


Bad Day For Homebuilders

Homebuilders and home construction companies got hammered today in the US. The cause of the decline was the proposed new tax reform package, and especially the changes to the mortgage interest deduction rules (see here and here).

The broader homebuilding industry represented by the XHB ETF and the home construction companies represented by the ITB ETF declined by 2.48% and 2.43% respectively. This is possibly their biggest one-day move year-to-date.

Let’s see their daily charts:

Source: Stockcharts.com

The XHB trended nicely all year, and from end of August it started to outperform the broader market (lower panel). Today’s decline found support at the lower end of a small retracement in October. There is also a rising trendline – when connecting the August and September lows – acting as support.

What’s worrying is the negative divergence between the price and the MACD and Stochastic indicators, which normally is a sign of trend exhaustion. Also on the lower panel the relative strength line broke a short-term rising trendline, indicating weakness versus the broader market.

Source: Stockcharts.com

The home construction ETF looks a tad better, today’s decline found support at a rising short-term trendline, there is no clear divergence between the indicators and the price, while the rising trendline in the lower panel is still in play for the relative strength ratio. What’s striking is the Stochastic that has been above the overbought level since the beginning of September, and this time it really signaled strength than an opportunity to sell.

Tomorrow is going to be interesting for both ETFs, whether these support levels hold or there is more downside to come.

Disclosure: We are long ITB and XHB.


US Mortgage Rates Tick Up

US mortgage rates have been increasing since September according to Freddie Mac’s survey:

Source: Freddie Mac

The 30y fixed stands at 3.91% which looks like this year’s average. It is worth looking at a longer period to get some broader perspective what this rate means:

Source: Freddie Mac

What is striking from this graph is that we are way below the previous cycle’s lows, which was 5.21% in June 2003. What’s more, we haven’t seen as high as that rate in this cycle (from 2011)!

Another food for thought: The ultimate low was reached in 2003, and mortgage rates increased slowly until right before the recession started in 2007. This means that even if we have reached the bottom of this cycle, the party can go on in spite of rising mortgage rates. Add multi-decade low rates to this and theoretically, this bull run in housing has more room to go.

Another interesting point is the spread between the 30y mortgage rate and the 30y treasury yield. Looking at the past 1y shows that the average spread was 1%, and the survey lags the movement in the 30y rate by a few weeks:

Source: Bloomberg

Looking back until 2000 shows that the average in the previous cycle was around 1.50%:

Source: Bloomberg

The upshot: mortgage rates are historically low and even if they rise further from here, this rise alone is unlikely to derail the recovery.