The stock market is getting a lot of post-facto praise in the popular press, now that the S&P 500 is flirting with an all-time high and the Dow Jones has soared strongly past the 14,000 mark. Not only is the Dow Jones climbing to more all-time highs, but it is enjoying its longest rally in over fifteen years, driven by “bolstered optimism in the world’s largest economy,” as Bloomberg puts it.
Since 2008, a lot of doom and gloom press has focused on the disconnect between rising equities and the reality on the ground–the Wall Street vs. Main Street dichotomy. This reading focuses on high unemployment, falling wages, and deep and growing income inequality amongst the top wage earners and the bottom wage earners. Those who see this disconnect as a reason to be bearish on the U.S. economy can also point to low volumes and lowered earnings expectations for several large-cap companies as evidence that, in fact, the economy isn’t as rosy as the Dow Jones records would suggest.
The debate remains unresolved, even if the market sentiment is clear. What will make this trend of rising stock prices sustainable for many large-cap firms is greater consumer confidence and more consumer activity in the United States. There are many indicators to track this aspect of the economy, and an often overlooked but important indicator is mortgage rates.
Why Rising Mortgage Rates are a Bullish Indicator for Stocks
Low mortgage rates are a necessary evil for retail banks that need mortgage activity for their top and bottom lines. Bank of America (BAC) and Wells Fargo (WFC) are most heavily invested in the U.S. mortgage market, and both are dependent on people refinancing and buying homes to bring earnings to their investors.
Low mortgage rates encourage refinancing, which has been the majority of mortgage activity in recent years. Bolstered by government programs to help underwater borrowers, banks have seen a tremendous rise in these transactions, while home purchases have remained moribund. Refinancers, of course, want the lowest rate possible, and their decision to get a mortgage is based largely on the rate they can get.
Homebuyers, on the other hand, will get mortgages for a slew of other reasons, some much less rational than the refinancer’s motives. Homebuyers will be less sensitive to higher mortgage rates because they are looking to buy a house, not just to getting the best rate possible. While rates are certainly a factor, it isn’t the only factor in their decision to buy a home.
Rising mortgage rates will not deter homebuyers, so banks can only raise mortgage rates if they are confident that there are enough homebuyers to offset those refinancers who are deterred by the climbing rate. Now that mortgage rates have risen to a six-month high, there is a sense that growing employment, low home prices, and a slowly but steadily recovering U.S. economy may give banks a strong enough position to raise rates. Thus rising mortgage rates are evidence of growing confidence in the overall economy.
However, banks are not always right, and the Mortgage Bankers Association has reported that mortgage applications are down. The dip is small and may disappear but, if it doesn’t, it may prove the banks wrong in their hypothesis that consumers can tolerate a slightly higher mortgage payment now that the economy is improving. For investors, they can choose to ride the wave as investors follow the banks and bet on stronger consumer confidence and spending, or they can choose a contrarian view and bet against that scenario by shorting sectors or the market as a whole. Either way, mortgage rates and applications are a good indicator to keep an eye on.