This Week's Hottest Sector

Newton's law of inertia doesn't always work in the stock market. For example, the S&P 500 index has lost about 11% of its value since Dec. 31, yet railroads -- CSX (NYSE: CSX) and Norfolk Southern (NYSE: NSC), for example -- are in the green on the back of record commodity prices and decreased demand for truck freight transport.

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Stocks in the same sector have a tendency to move in tandem, regardless of overall market conditions. After all, they usually get their revenue from similar sources, and they're similarly affected by events.

Each week, we'll take a look at the hottest sector over the past five days, according to SmartMoney.com's Sector Tracker. Then we'll cross-reference the individual equities against investor data on Motley Fool CAPS, the Fool's free investing community. CAPS can give us a better feel for what both individual and institutional investors say about these stocks.

A surprising sector
This week's top sector is Mortgage Finance, up an astounding 39% in the past five days. This group includes:

An overreaction?
Mortgage finance stocks across the board have been beaten down over the past year, as concerns remain about the companies' respective roles in the subprime mess, a declining interest rate environment, and a widespread housing slump.

While the answers to those concerns are still largely up in the air, this week's rally was caused by the surge of Fannie Mae and Freddie Mac, which received much-needed support from the government, specifically the Office of Federal Housing Enterprise Oversight (OFHEO). On March 19, OFHEO announced that the two companies could lend up to an additional $200 billion by lowering their 30% capital requirements to 20%.

Basically, that's positive news for both the jumbo-mortgage market, which has been awry for some time now, and also for pinched homeowners who need to refinance their subprime loans.

Nevertheless, on CAPS, investors are still concerned about the American mortgage market.

One doubter is slimjohn, who isn't buying the government relief for Fannie and Freddie: "Reducing reserves is a dangerous proposition in this environment. They will have to call on the fed as these mortgages get worse."

On the other hand, player Favorableodds voiced belief just before the March 19 announcement that Freddie Mac was uniquely positioned to rebound:

The bottom line is that Freddie (with the exception of Fannie) possesses unscalable barriers to entry, and generates above average earning power during normal times, which common sense dictates is likely to only get stronger as current competition is nearly non-existent ... Those with the patience to wait should be rewarded with returns approaching 100% from today's prices within 2-3yrs.

So far, at least, that's looking like a smart bet.

But this Fool (me) would be hesitant to leap into this sector rally head-first. Despite the government's help, free-market forces may end up being the final judge on the mortgage mess. The mortgage market seems to be changing each day and with each announcement from Fed chief Ben Bernanke, so unless you're prepared for volatility, this might be one you'll want to sit out.

What do you think? Was this week's surge the catalyst that will send mortgage finance stocks soaring? Voice your opinion on Motley Fool CAPS, where more than 89,000 investors are waiting to hear what you have to say. It's 100% free.