The Problem With Homebuilder, Financial ETFs

NEW YORK ( ETF Expert) -- Americans are at it again. They are becoming wide-eyed at the prospect of real estate riches, convinced by media cheer-leading that the 2007-2009 collapse in home prices was a once-in-a-century anomaly.

Why shouldn't we be enthusiastic? Home values have been rising by double-digit percentages. Buyers are tripping over themselves to outbid one another. When the vast majority of participants still fail to understand leverage, they are easily persuaded by the promise of 100% paper gains on 20% down.

Yet, the stock market has a way of detecting problems long before they start. Take a look at 2007 -- a year when the stock market eked out a respectable gain on low volatility, but the SPDR Sector Select Financial Fund ( XLF) had declined dramatically. In essence, the investment community had already sniffed out the flattening of real estate prices, the waning of housing affordability and the bursting of a mortgage bubble.

Perhaps ironically, XLF maintained a modicum of relative strength over the broader market benchmark S&P SPDR Trust ( SPY) in 2006. Yet, as higher mortgage rates and higher home prices combined to push affordability out of reach, even with the rosiest of loan underwriting assumptions, XLF demonstrated eye-popping relative weakness by 2007. The rest (2008-2009), as they say, was history.

Flash forward to 2013. Over the last 10 weeks, XLF has gone from a remarkable outperformer to a definitive underperformer. Even the recent down tick in mortgage rates from roughly 4.75% for 30 years to 4.25% for 30 years has not served as comfort for big financial firms. Many of them have laid off workers in anticipation of ongoing weakness in financing and refinancing of real estate.

Already, banks have been working overtime to put a terrific spin on upcoming earnings. They've lowered estimates in advance so that they might still beat "expectations" in third-quarter reports. Nevertheless, the extraordinary drop in mortgage volume challenges the ability of CEOs to provide strong guidance going forward. The Federal Reserve may still have the stock market's back, but will it be able to push financial stocks back into the lead? Right now, the only sector with worse performance over the prior three months is the consumer staples segment.

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