Is A Welcome Surprise Coming For Mortgage Rates?

 |  Includes: AGNC, KBH, NLY, NYMT, TPH, WMC
by: John Gilluly

One of my seven year-old's favorite quips is "Daddy, are we there, yet?" and I always answer, "No, but we will be." Much could be similarly said with the housing market this year. Just how good a year it's going to be - I don't know - but it's going to be a good one in any case.

Unexpectedly, stars appear to be aligning which could bring buyers back into the market precisely at the beginning of the Spring selling season.

Mortgage rates were 4.7% the first week of January. Today they are closer to 4.3%. The interest rate spike of 2013 looks like it's abating. Are cooler heads in the bond market now prevailing?

If so, even though it comes as a surprise after the angst of the last 6 months, I don't see anything "on the street" (yet) that reminds me of the boom economies of the 1950s and 60s - and that was the last time that interest rates rose from generational lows and popped through 5% for the first time in 30 years.

In my opinion, every time the Fed tapers $10BL in MBS and another $10BL in treasuries (about a 12% cut) from the original stimulus, it could result in a fractional cooling of the economy and another 10 basis points off the 10 year treasury. Scott Grannis might just be right (See: Quantitative Easing Myths, by Scott Grannis, November 19, 2013).

Such a scenario would be good for the builders, the mortgage market's buyers and re-fiers, and especially good for that extra 200k in housing starts the builders broke ground on in November, 2013. Those starts will be models in the showroom and open houses on the street by April.

There are 3 things needed to moderate the inventory squeeze that has been plaguing the real estate market for two years: enough new homes for buyers, more affordability and lower mortgage rates.

A steady moderation in interest rates would also be welcome for the mortgage REITs, because a steady spread between the short and long end of rates helps secure their dividends. What killed the mREITs in 2013 was the sudden volatility in rates.

After the worst year in a decade, the likes of Annaly Capital Management (NYSE:NLY), Western Asset Management (NYSE:WMC), American Capital Agency (NASDAQ:AGNC) and New York Mortgage Trust (NASDAQ:NYMT) look like good opportunities in 2014. There has also been massive insider-buying in these names.

Lastly, readers occasionally ask me for short-term ideas. I usually list the same half-dozen builders in my articles: Toll Brothers (NYSE:TOL), KB Home (NYSE:KBH), Brookfield Residential (NYSE:BRP), Tri-Pointe Homes (NYSE:TPH), Standard Pacific (SPF), DR Horton (NYSE:DHI).

I prefer the California builders because I am familiar with this market and have good available research (Beaconeconomics; John Burns Consulting). I also like the mREITs because of the kind of year they had in 2013. A lot of risk was squeezed-out of them last year. Some of these names are now trading at 80% of book value.

A technique that worked well for me both in 2012 and 2013 was to buy homebuilders with high short-interest early in the Spring time.

The bearish thinking is that a bet against the economy is an easy bet against the builders, because they are so economically sensitive.

But what if that bet is wrong?

Since its IPO in January 2013, the short-interest in Tri-Pointe (TPH) has increased 400%. I like it now at $17.50 just as much as I liked it at $14. KB Homes (KBH) short-interest has almost doubled since May 2013. I wrote an article about these two builders in September 2013, and have done well ($) in two short squeezes affecting them. Days of high volatility create the best entry points. (See: KB Home And Tri-Pointe: Short-Interest Or Short-Squeeze?, September 26, 2013).

For readers with a further interest in the development of my ideas on mortgage rates and the housing market, see:

Disclosure: I am long BRP, WMC, NLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.