Housing market continues to be 'a horrible risk reward' amid Fed rate hikes: Strategist

Piper Sandler Chief Investment Strategist Michael Kantrowitz joins Yahoo Finance Live to discuss the state of the housing market amid the latest Fed rate hikes and also weighs in on why bitcoin won't bottom just yet.

Video transcript

DAVE BRIGGS: September historically the worst month for stocks. Is this going to be any exception?

MICHAEL KANTROWITZ: You know, seasonality is always something to think about. Sell in May, go away. Or we have a midterm election, so we've got a political cycle going on. There's a lot of cycles. And oftentimes, I find investors only focusing on one cycle, like seasonality or the election or the inflation cycle or the business cycle. You really have to think about all of them together to really come up with a strong investment conclusion. So today, we've had a lot of different cycles between commodities rates, policy, housing.

And so I think, yeah, it's going to be another difficult month for the market, especially after Chairman Powell's pretty clear message that he gave about a week ago. We continue to see leading economic data around the world deteriorate. And today, with mortgage rates nearly back to the highs, the worst housing gets, the worst the US economy is going to get, and the worse the stock market's going to perform just to simplify it. So I do think so, yeah.

RACHELLE AKUFFO: Well, since Fed chair Powell has made it clear that the Fed is not going to take its foot off the gas when it comes to tightening and high rates, in terms of what you're expecting in terms of an investment strategy at this point, when you do have so much economic data coming at you, what's the play here?

MICHAEL KANTROWITZ: Yeah, and so for economic data, it's really important to differentiate and understand which data are leading, which data are coincident lagging. A lot of the pushback we get from more bullish investors today, and we do have the lowest year end number on the street. Of all strategists at 3,400, so we get a lot of pushback, as you can imagine, most of it is come-- is really regarding coincident lagging economic data, such as loan growth is still strong.

Earnings are still OK. Employment's still firm. All of that's true, but those are all lagging economic indicators. Things that lead those indicators consistently across time are telling us that the best days are behind us for those data and expect that to continue to deteriorate.

SEANA SMITH: Mike, what's going to be the catalyst to change things around? Is it only inflation, or are you looking at something else that would make you a little bit more bullish on your outlook for equities?

MICHAEL KANTROWITZ: More bullish. I would say, we'd have to see the beginning of a stabilization in the US housing market because I have looked back at every single major correction, bear market, back to 1950, and it's very clear that you do not get the beginning of a new bull market until you start to see housing in the US economy stabilize, which is the early, early part of the economy that first rebound.

So for example, in 2019, when Powell pivoted the end of the year, we saw the NHB Index, builder sentiment, begin to recover immediately and go up 20 points in 2019. That was a clear sign the US economy was not heading into recession. And that was going to start to recover. So with mortgage rates at their highs here, hard to really get optimistic about housing in the US. Inflation coming down is good news.

However, the lagged effect of the inflation we've already seen is still going to be weighing on the economy for the next several quarters. And then on top of that, we've got the Fed that's still aggressively raising interest rates. And I would argue, outside of housing, we haven't even begun to see that. So from my perspective, the way our framework from a macro perspective looks at these markets, we believe that they continue to be a horrible risk reward.

DAVE BRIGGS: Horrible risk reward. We haven't even begun to, the Fed, sell mortgage-backed securities. So how much worse might the housing sector get?

MICHAEL KANTROWITZ: Well, if that keeps rates high, then, again, there's just nothing that's going to allow it to improve. In 2019, the only issue we had regarding housing was high interest rates. Home prices were not elevated like they are today. And so when rates came down, immediately, we saw a big recovery. Today, we've got a much broader problem in the global economy. And so I think it would take a lot, even more than rates, to coming down to get housing to recover because prices are still really high. Affordability is pretty poor. And so I don't think there's really many green shoots that are out there right now.

RACHELLE AKUFFO: And Michael, I want to talk earnings because in your note, you talked about the markings of an earnings driven bear market. How are we making that distinction versus other bear / and how is that informing your outlook?

MICHAEL KANTROWITZ: Yeah, I think there's a really important nuance in this bear market that we have going on today, which is that, really, the first six months of the bear market, it wasn't about earnings. It really wasn't about the global economy collapsing. It was really about interest rates going up, inflation going up, and multiples being reset as a result of that. And that is not a familiar bear market to anyone who hasn't been investing for more than 40 years.

So that's certainly me and probably 95% of investors today. We've gone through and we are in the middle of an inflation and interest rate driven bear market, which is very different from what we saw ultimately in 2000 and 2008, which was an earnings bear market. Earnings estimates have peaked. They peaked ironically in the middle of June right around the same time where the market bottomed.

And so I would actually argue that that rally we saw in June, July, into mid-August was ironically a result of-- or in other words, the market was kind of celebrating the onset of a recession in that the market was celebrating weak data because it meant potentially less Fed rate hikes. And oil has collapsed pretty hard probably because we're starting to see demand dry up and economic data slow. So ironically, the rally was really about bad data, which is kind of counterintuitive, which is why it also doesn't last.

So earnings expectations are still way too high. I don't think that's unusual or out of consensus at all. We've been saying that all year, and pretty much most people are saying it today. The earnings estimate for 2023 as of right now is $243.76. We think that estimate is going to fall about another 6% by year end to about $230. And as that takes place, we think there's also going to be pressure on the market multiple as we see credit spreads widen and the employment data deteriorate.

So that's how we get to our 3,400 year end target at about a 15 to 16 multiple times 230 estimates for next year. Now we don't think that's the low or nor do we think that's what earnings are going to be. We just think that's where consensus will be at the end of this year.

SEANA SMITH: Hey, Mike, real quick, while we got you, we have to talk about Bitcoin, right? We've been watching the slide that we've seen in crypto. Today, though, we're seeing Bitcoin back above 20,000. Do you think there's more downside risk and how big of a drop could we potentially see?

MICHAEL KANTROWITZ: Yeah, you know, I'm not a big Bitcoin fanatic. It's not really part of my wheelhouse. But about two years ago, I observed that Bitcoin was basically trading exactly like the relative performance of high to low beta stocks. So it's essentially a beta trade. And that relationship has been locked tight, really, for the last two years or so. And so that means it's a macro trade because beta is a macro factor.

And so we're very bearish on high beta stocks until we see a bottoming in leading economic indicators like the NHB index and the ISM index. And so anything that looks, walks, talks like beta-- Bitcoin is a clear example-- is something we want to definitely avoid. And so we've seen a bit of a stabilization in things like Bitcoin and beta in this market rally. That's, I think, over, and that's why we're beginning to see more pain ahead.

So I said we published many, many months ago that I think Bitcoin is around 40,000 that we're going to probably see it get cut in half and then some. And then we reiterated that recently. So, you know, I could easily see it falling down to 15,000. Again, this is not a long-term view on Bitcoin at all. It's purely a cyclical view with the realization that it's trading exactly like the market today. So until we see a bottom in the economy, I don't think we're going to see a bottom in Bitcoin.