Opportunity To Get Ahead Of The Curve?

At the end of March, interest rates now sit at 6.32% average across the country for a 30-year fixed rate mortgage. While this is lower than a few weeks ago, they are still much higher than a year ago.

The cause is that the Federal Reserve has been raising rates aggressively over the last year to fight persistently high inflation. The Fed's goal of raising rates is to slow the economy and bring inflation back down to a normalized level or target goal of 2%.

Raising rates makes large capital expenditures for businesses or individual households more expensive, thus creating a situation where it is no longer affordable or makes good business sense to make those investments.

Fewer large investments or fewer new homes being built because the financing costs of making those purchases are too high will eventually slow the economy and thus bring inflation down.

While we all want inflation to come down quickly, it takes time for high-interest rates to flow through the system and change business leaders' and households' decision-making.

Furthermore, there is a rather big delay with the economic data that tells us how the economy is performing and whether or not large investments, home purchases, and overall spending is slowing.

This all means that when we realize business leaders-consumers have changed their minds about what investments and purchases are worth making, the economy is already slipping.

If we now look strictly at the household side of the equation, it seems clear that this group is heading toward tough times in the not-so-distant future, thus making the idea of a new home purchase much less likely.

First, we have high inflation. This is making everything across the board more expensive. Consumers' average cost of living is increasing, whether it be groceries, child care, transportation, or clothing.

Then we have higher interest rates on top of those higher daily living costs. This is making a new mortgage more expensive.

And finally, we throw in the fact that consumer debt is now at all-time highs. These combined factors paint a bleak picture of a strong housing market in the near term.

Although, if we look at the exchange-traded funds focusing on home builders, they are up 10% or more year-to-date, while the S&P 500 is up less than 4%.

I believe this is an opportunity for investors to get ahead of the curve and short the home builders before we see definitive data that indicates the economy and housing market is beginning to struggle.

A few of the basic, non-leveraged ETFs that you could short are the iShares U.S. Home Construction ETF (ITB), the SPDR S&P Homebuilders ETF (XHB), or the Invesco Dynamic Building & Construction ETF (PKB). You could open a short position in any of these funds or buy put options on them.

If you want to get more aggressive, you could short or buy put options on either the Direxion Daily Homebuilders & Supplies Bull 3X Shares ETF (NAIL) or even the Direxion Daily Real Estate 3X Shares ETF (DRN). These are both three times leveraged to the upside. So if you short them, and they decline in price, you would be getting three times as large of a move. However, this does add to your risk.

If you are uncomfortable with open short positions or buying options, you could also buy the Direxion Daily Real Estate Bear 3X Shares ETF (DRV), which is three times leveraged to the downside of the real estate industry.

The downside is that DRV is more of a real estate ETF than directly focusing on the housing industry. So, if the housing industry does turn negative, you may not realize the lion's shares of the move lower.

Regardless though of whether you directly short the homebuilding ETFs, use options, or play the leveraged homebuilding ETFs, there is a lot of risk with this trade.

First, you are shorting the industry that has not yet shown real signs that it is cracking.

Second, it may take months for data to show that this is a smart trade today.

And finally, you are shorting stocks, thus limiting the upside to your investment but opening yourself up to a lot more risk.

This is not a trade for everyone, and by no means is this a 'for sure' type of trade. It is a trade based on many assumptions about the consumer's overall health at this time and where they may be in a few months.

Ensure you fully understand what your risk is before making any decisions.

Matt Thalman
INO.com Contributor
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

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