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Mortgage interest rates are at the highest level in two years, pushing some buyers off the sidelines...The initial rise in interest rates provided strong incentive for closing deals. However, further rate increases will diminish the pool of eligible buyers. - Lawrence Yun, Chief Economist of the National Association of Realtors, on today's existing home sales report for July

Today's existing home sales report came in at a 5.39 million seasonally adjusted annualized rate for the month of July. This result was not unexpected, as I'll explain, and I would strongly recommend using yesterday's and today's jump higher in the housing stocks to unload long positions and, for aggressive traders, establish or add to short positions.

Although an existing home sale is not recorded until the escrow closes (as opposed to new homes sales, which are recorded when the contract is signed), the existing home sales report is a lagging indicator of housing market activity due to the average time it takes between signing a sales agreement and closing escrow. Because of this, the July existing home sales report reflects both contracts that were signed before interest rates spiked up in mid-May and buyers who were willing to close despite having to pay a higher rate on their mortgage than originally envisioned. Going forward, I expect existing home sales to decline precipitously and, apparently so does the Chief Economist of the National Association of Realtors (see the opening quote).

A much better indicator of current housing market conditions is the mortgage applications index published by the American Mortgage Bankers Association. This index has a one-week lag and it's been in a literal free-fall since early April. The chart below (sourced from Zerohedge.com) shows mortgage applications vs. existing home sales:


(Click to enlarge)

As you can see, there has been an extreme divergence between mortgage applications and home sales. While the index is for both refinancings and purchases, purchase applications have been in a downtrend since mid-February and existing home sales from August forward will reflect this.

The positive existing home sales report for July posted today can be explained by two factors. First, there was no doubt a rush by buyers to lock-in financing and close their home purchase regardless of the final mortgage rate at close. This is a behavioral phenomenon that has been discussed ad nauseum over time.

But the second factor is the lag between making the decision to buy a home and closing escrow. "Closing escrow" means all the documents involved have been verified and signed and the deed is transferred to the mortgage lender or the new owner. This process takes anywhere from 30 to 60 days and, in some cases with bank-owned property, three months.

What this means is that the existing homes sales data for July were comprised of home sales that could have involved contract signings and mortgage rate-lock agreements that stretched back to late April or early May, before rates spiked higher. Although we don't have access to the actual data, it is highly probable that a large portion of July's sales - i.e. escrow closings - were based on contracts and rate-lock agreements that were signed before the mid-May surge in interest rates and, therefore, July's sales were heavily front-end loaded.

Based on indicators that I'm observing all around the metropolitan Denver area, I fully expect that both existing and new homes sales reports for August and forward will reflect an abrupt and steep decline. I also expect to see the inventory numbers, as reported by both the NAR and the Census Bureau to spike higher and prices to start declining.

The Dow Jones US Homebuilder Index (DJUSHB) has jumped 4.5% since Monday's close. I recommend using today's strength to unload long positions, if any, and go short. After Friday's housing market sentiment report, the DJUSHB jumped 14 points (3.3%) at the open and closed flat on the day, after briefly going negative. I expect the same thing to occur today, followed by an extended move in the DJUSHB that will establish new yearly lows. I still love my DR Horton (DHI) short position and will add to it today. I also like shorts in Ryland (RYL), Pulte (PHM), Centex (CTX), Lennar (LEN) and, for the those with nerves of steel and strong stomach NVR (NVR).

Source: Sell Today's Existing Homes Sales Report