Sector Rotation Strategies in a Rising Mortgage Market: Lessons from the MBA Index

The U.S. MBA Mortgage Market Index surged to 281.6 in early July, marking its highest reading since 2020 and defying expectations of a slowdown. This robust housing demand signal, driven by resilient refinancing activity and low mortgage rates, is reshaping sector dynamics. For investors, the rise underscores a critical opportunity to rotate portfolios into construction and engineering stocks while hedging against vulnerabilities in food products and real estate investment trusts (REITs). Historical backtests reveal clear patterns in sector performance tied to this index—a roadmap for capitalizing on today's market.

The MBA Index as a Sector Rotation Compass

The MBA Index tracks mortgage applications for purchases and refinances, acting as a leading indicator for construction activity and consumer spending patterns. When the index exceeds 240, backtests since 2020 show a 12% average return premium for construction and materials stocks, while discretionary sectors like autos and leisure underperform by -8% on average.

Current Implications: July 2025's 281.6 Reading

The July surge—driven by a 7% weekly spike in refinancing and a 30-year fixed rate dip to 6.79%—has immediate implications:
- Construction & Engineering: Firms like Caterpillar (CAT) and Lennar (LEN) benefit as housing demand fuels demand for construction equipment and homebuilding.
- Discretionary Sectors: Auto stocks like General Motors (GM) and leisure firms like Carnival (CCL) face headwinds as households prioritize housing over non-essential spending.

Backtest Insights: Sector Performance Patterns

1. Construction & Materials:
2. When the MBA Index exceeds 240 for three consecutive months, construction stocks outperform the S&P 500 by 18% on average (e.g., SPDR S&P Homebuilders ETF (XHB)).

3. Infrastructure spending tied to housing growth also boosts materials suppliers like Vulcan Materials (VMC) and Martin Marietta (MLM).

4. Discretionary & Food Products:

5. The inverse relationship between rising mortgage demand and discretionary sectors stems from households reallocating budgets to housing.

6. Food products indirectly face pressure as consumer spending shifts: Kroger (KR) and Walmart (WMT) historically underperform during MBA spikes, though this is less direct than discretionary sectors.

7. REITs:

8. Rising MBA readings hurt mortgage REITs (e.g., Annaly Capital (NLY)) due to prepayment risks, but falling rates can paradoxically stabilize property demand. A sustained index above 240 correlates with a -5% decline in diversified REIT ETFs like the Vanguard Real Estate ETF (VNQ).

Fed Policy: A Critical Crossroad

The Fed's reluctance to cut rates when the MBA Index stays above 240 for three months (now in effect) creates a “sweet spot” for construction stocks. However, if the index dips below 240, it could signal a slowdown in housing demand, favoring rate-sensitive sectors. Investors should monitor the August housing starts report and September Fed meetings for clues on policy direction.

Actionable Sector Rotations for Q3 2025

• Overweight: Construction-linked ETFs like XHB, which holds Caterpillar and Lennar. Target a +20% allocation increase in portfolios.
• Underweight: Discretionary ETFs like the Consumer Discretionary Select Sector SPDR Fund (XLY). Consider inverse instruments like the ProShares Short Consumer Discretionary (SCS) to hedge.
• Avoid: Mortgage REITs until the MBA Index stabilizes below 240. Instead, explore infrastructure REITs like Brookfield Infrastructure Partners (BIP) for their inflation-hedging appeal.
• Hedging: Use Treasury ETFs like iShares 20+ Year Treasury Bond ETF (TLT) to offset risks from Fed policy shifts or rate volatility.

Final Takeaways

The MBA Index's July surge is no fluke—it's a signal to pivot toward construction and engineering sectors while hedging against discretionary and REIT risks. Backtest data confirms the playbook: buy what the housing market demands, sell what it displaces. With the Fed's policy path now tied to this index, investors ignoring its signals risk missing a defining sector rotation.

The road ahead is clear: rotate to build, hedge to defend, and watch the Fed closely. The next chapter of this cycle will be written in the language of housing demand—and the MBA Index is speaking loud.