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Homebuilder sentiment ‘has deteriorated rapidly’ amid rising rates, strategist says

Charles Schwab Senior Investment Research Manager Kevin Gordon joins Yahoo Finance Live to discuss U.S. mortgage rates, homebuilder sentiment, rate hikes, inflation, market uncertainty, and the outlook for the economy.

Video transcript

- Welcome back to "Yahoo Finance Live," everyone. Major averages holding onto gains this morning after the Dow finished yesterday's trading session in a bear market, as concern surrounding the world economy takes center stage. For more on the latest market action and sentiment, we've got Kevin Gordon, Charles Schwab Senior Investment Research Manager. Kevin, thanks for joining us in studio, live in living color this morning. You say that investors don't need to wait for the Fed to break something. Break that down for us.

KEVIN GORDON: Well, I think if you look at the housing market, it's already happening. And you kind of have to break it down in the different phases that you tend to see with weakness in housing, starting on the sentiment side, so something like the NAHB. Housing-- homebuilder sentiment has deteriorated rapidly.

And if you look at rates of change within whether the headline index itself or prospective buyers traffic, that is firmly recessionary. And it's starting to wade into other areas like home sales. New home sales, existing home sales have been basically cut in half from their peak. And now you're starting to see it creep a little bit into prices. But we haven't gotten there yet.

And that is the part that's the issue really for inflation and ultimately, for the Fed and the broader economy because they're looking at that not coming down as rapidly, feeding into higher rental inflation. That's going to be a little bit stickier later. But if you want to look for something that's breaking, I would say it's already happening in the semi components of housing itself.

- Yeah, we just got house price numbers, but they're for July. So it's trailing. We get new home sales out at 10:00 AM. Talk to us about how we should think about-- like, I mean, we know why housing is important. But sort of put it together for us. And when we look at home ownership rates in the United States, et cetera, why is it such an important thing to look at for the status of the overall economy?

KEVIN GORDON: Well, the ripple effects from housing are massive, not just from a confidence angle, but also when you think about affordability, the fact that monthly payments have gone up significantly for homeowners. But also the potential entry into the home market is completely almost been shut for would be homebuyers because of the spike in mortgage rates because home prices have taken longer to come down.

So I think that in terms of slowing down the economy, you could do it pretty effectively. But it also, in a good sense, I would say that the positive spin on the housing bubble this time, more so the price bubble, not anything akin to what we saw in '05, '06, is that you don't have high debt service to income ratio. You don't have high household debt relative to income. So that is the positive aspect this time.

But for the Fed and then wanting to sort of stem any of the inflationary pressures and keep it at bay, that's largely been successful. But we have to now see and wait for it to feed into lower price growth over into the future.

- Kevin, investors waking up today, they're awakening to see all three major indices in a bear market. And investors have been largely taught that investing in something that tracks these indexes is the best way to go. But is that broken? Does that still work? Should investors be more now pivoting to stock picking, especially given the pullback we've seen, like in tech, for example?

KEVIN GORDON: Yeah, I mean, we've been in favor of a little bit more of an active approach as the bear market progresses here. The only rub with it now is that correlations have picked up a lot. So if you're entry point is around now, which I wouldn't argue over for a get in or a get out strategy, but if your entry point has gotten a little bit closer to the near term, it's a little bit tougher to do that.

But there are still factors that work. And I know last time I was here, we talked about screening for high quality, specifically earnings quality. And that has been actually the key outperformer, not just the past three months, six months, or year to date for the past year. That's been where you've been able to find consistent outperformance across every sector, whether it's energy or tech.

- How do you know what's quality? Like, what defines quality in an environment that where GDP is barely growing?

KEVIN GORDON: Anything with earnings strength, whether it's trailing profit margin growth or forward estimated profit margin growth. And specifically, the market's going to put a premium on whatever is scarce. So if you look at the percentage of companies in the S&P, for example, that have positive earnings revisions, that have had them over the past three months, it's only 30%. That's down from about 90% a year ago. So that rapid deterioration has elevated the companies that have done really well from that earnings profit margin forward-looking perspective.

- What about on the employment front and particularly on the unemployment side? What we've been hearing is that even if we're looking quarter over quarter now, and actually a year out from now thinking about when the deepest components of a recession might hit, what unemployment may actually look like at that point in time. What would you be tracking most notably going into that period too?

KEVIN GORDON: Well, in the leading sense, claims for sure. The good aspect of that from the consumer or the employee perspective is that claims have started to roll over. So we've reclaimed almost half of that spike that we've seen since April, which is great, not so great from the Fed's perspective because that just signals that company demand has actually been relatively strong if people have been able have been able to find jobs at a quicker pace.

But moving more into the coincident areas, like non-farm payrolls, even within that, non-farm payroll growth still looks pretty strong. But if you look at something like the household survey, they both diverged. Household survey has been relatively flat. Non-farm payroll survey has still been strong and then in a lagging sense, the unemployment rate, which we would never look at for any sort of leading indication as to where the economy is going.

But implicit in the Fed's forecast, you sort of bring up where unemployment can go is a 4.4% unemployment rate by next year. That's a 0.7% jump from where we're at right now. That's a recessionary type jump when you look back at history for the trough in the unemployment rate to the start of a recession.

So I just think from our broader perspective and all of us at Schwab, it's really tough to thread that needle and to sort of get this immaculate scenario where you have GDP just sub trend growth with unemployment rising a little bit and inflation coming back down. One of those sort of has to break and not really work. I mean, I would argue that probably unemployment, once it's out of the bag, it's really hard to get back in.

- Well, there's a lot of stuff breaking out there. But Kevin Gordon, good to see you in the flesh.

KEVIN GORDON: Thanks, guys. Good to see you.

- I appreciate you coming down. These are busy times. Charles Schwab Senior Investment Research Manager, good to see you.