Why the Dow's Housing Bounce Is Dangerous

The Dow Jones Industrials (DJINDICES: ^DJI  ) have continued their string of recent gains this morning, up more than 150 points as of 10:55 a.m. EDT. Much of the enthusiasm among investors came from some promising economic reports, including weekly jobless-claim numbers that fell by 9,000 to 346,000, as well as a 0.5% gain in personal income that beat out a 0.3% jump in personal spending. In addition, strength on the housing front continued to bolster the economy, with the National Association of Realtors reporting that pending home sales jumped to six-and-a-half-year highs after a 6.7% increase in May.

Clearly, the financial health of consumers in general is of paramount importance to stocks throughout the economy, as consumer spending drives the majority of economic activity and can therefore make or break an economic recovery. But as for the housing-specific data, investors should be cautious before reading too much into this month's favorable data.

The specific danger to the housing market's recovery comes from mortgage rates, which have surged in the past two months by more than a full percentage point. The NAR noted in its report that in the short run, higher mortgage rates might have prompted greater numbers of contract signings as buyers rushed to take advantage of previously locked-in rates or sought to get financing before rates could rise even further. Big banks JPMorgan Chase (NYSE: JPM  ) and Bank of America (NYSE: BAC  ) , which have risen 1.7% and 1.1%, respectively, likely owe at least some of their gains to optimism among investors that mortgage-lending activity can survive the recent rate increases.

The problem, though, is that banks face a potential double-hit in the longer term. As rates have risen, refinancing activity has already slowed down considerably; the Mortgage Bankers Association Refinancing Index has fallen to its lowest levels since November 2011. As a result, banks will have to rely on new-purchase activity to a greater extent. Economists are uncertain how long the rush to buy might last, and eventually the higher payments that rising mortgage rates require will have a large enough impact on affordability to create headwinds for B of A, JPMorgan, and other mortgage lenders.

What's unclear is how rates will affect Home Depot (NYSE: HD  ) and its home-related business. Home improvements aren't entirely dependent on purchase activity, and Home Depot managed to succeed even during the housing-bust years by focusing on homeowners and contractors trying to improve their existing residences. As a result, Home Depot is much more likely to hold up well so long as broader measures of consumer income are strong.

Nevertheless, the point here is that housing has become a linchpin of the overall economy, so it's important to temper your views of economic strength based on a single month's numbers. Otherwise, you might well draw incorrect conclusions about the recovery's ability to continue.

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