According to the report, U.S. homeowners had a tough time staying up to date with mortgage payments in Q4 2006, with the delinquency rate leaping to 4.95% from 4.67% thanks to subprime mortgages, where delinquencies rose to 13.33% from 12.56%.

To be painfully honest, we wouldn’t be surprised if a similar fate befalls those indices between June 11-15, 2007. That’s the date range for the next Mortgage Bankers Association mortgage delinquencies report (the actual date won’t be known until we get closer). Any negative MBA read will only re-strengthen lingering fears that mortgage delinquencies will eventually force consumers to cut back on discretionary spending as lenders tighten credit in the housing slowdown.

Economically speaking, we then have a problem. Once consumers spend less, the economy stops growing, and our beloved stock market rally comes to a screeching halt, and turns south.

Plus, the economy must still contend with the probability that 1.1 million additional home foreclosures will transpire over the next six years as adjustable rate mortgages reset at higher rates. These foreclosures account for about 13% of ARMs originated or refinanced from 2004 to 2006, which equals about $326 billion in debt.

Worse still, existing homes sales fell an unexpected 2.6% in April to 5.99 million, the lowest level in about four years, according to Bloomberg.com. This only adds to concerns that unsold home glut will further depress prices this year. Tragically, given the backlog of homes, existing home sales may have to drop further. This, plus increasing food and energy costs, will cut into discretionary spending, which could lead to a higher unemployment rate, which could lead to a significant slowdown in consumer spending, which could lead us into an environment that would not be good recession-wise.

Scarier, and what could prove even more tragic, according to International Forecaster (as quoted in a GoldSeek.com article), “Sixty-five percent of hedge funds are leveraged to subprime and ALT-A mortgages and could be in deep trouble.”

Still, next month’s report gives us an opportunity to profit on the short side and the long side. The short side opportunity is to buy VIX calls on increased report-induced volatility, mirroring that of March 2007’s rise, plus any investment banks with heavy subprime exposure. Death Cross Trader will issue this trade shortly. As for profiting on the long side, an argument can be made for uptrend resumption on strong economic and earnings news. An irrational market has a tendency to shake off extremely bad news, in the presence of any good news.

Sincerely,
Ian Cooper
May 29, 2007

P.S.: Death Cross Trader exploits overpriced stocks and the naïve investors who buy them, with an 86% accuracy rate with average gains of over 26% on every single recommendation! In fact, we now have 48 winners out of 56 picks for total gains of 1,485%… If you had put $5,000 into each trade, you could now be seeing as much as $74,267 in pure profit!

Investing in the Declining Real Estate Market was originally featured in the Penny Sleuth.