What is the fall in pending home sales telling us?

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Pending home sales fell 2.5% in November from the prior month but is this really a warning the economy is doomed? Not exactly.

The pending homes sales report tracks real estate contracts for existing single-family homes and condos that have not yet closed. It is considered a leading indicator for existing home sales.

Economists are immediately pointing to the sharp increase in interest rates since the election as the culprit. A quick peek at the pending home sales chart shows that this is a volatile report to say the least.

The white line is the percentage change in pending home sales month-over-month. The orange line is the Freddie Mac US Mortgage Market Survey which tracks the 30 year mortgage rate in the U.S.

Pending Homes Sales vs. Mortgage Rates 

Pending Home Sales

It is pretty clear that when mortgage rates rise violently there is a steep fall in pending home sales. This happened leading up to June 2012 with the “taper tantrum” and also in November of 2016 following the election. The rest of the time there appears to be very little correlation between the month to month movements in the two data points.

Rates are higher, but not high enough to stop buyers

Mortgage rates have risen from 3.57% to 4.30% in a little over a month. That 73 basis point increase is massive movement in such a short time period and I’m sure it would be quite shocking to a home buyer if they didn’t lock in their rate. For a $200,000 mortgage, the monthly payment would have increased from $724 to $791. If a guy and his new bride found their dream home is $67 more a month going to stop them? Not likely. They will close the deal in order to not let that home slip away and be sold to someone else.

I’ll until January to see the December data but I don’t believe the move in rates is enough to stop the housing market at this point. In fact, I am still long LGI Homes (Ticker: LGIH), a small cap home builder out of Houston, TX. They are focused on the entry-level buyer which I think will continue to be strong as the millennials hopefully start earning enough with better jobs available to move out of their parents house to live on their own.