Is the housing recovery over? From one look at the homebuilder stocks you would think so. The steep climb in interest rates has taken the whole group into bear market territory and the $6.3 billion Pulte Group (PHM), builder in over 25 states, has been a leader of the decline.

At its May peak, the stock was trading over $24, which means its market cap was over $3 billion greater only 3 months ago. Since it became a Zacks #5 Rank Strong Sell on August 3rd, it has fallen another 8% from $17 to $15.65.

Here's a look at the trend of earnings estimates for PHM which shows how the dreaded Fed 'taper talk' has turned the outlook for this builder and others...

As we have watched stocks like Ryland (RYL), KB Homes (KBH), Lennar (LEN), and DR Horton (DHI) get clobbered by 25% to 35% since their May highs, PHM was down 40% last week. It is also the first of these to slip to a Zacks #5 Rank.

And while some of these names still sport a Zacks #2 Rank Buy, this is probably because analysts have not gotten around to lowering their estimates yet. The group as a whole carries a Zacks Industry Rank of 185 out of about 250, placing it in the lower third of industries.

This rout of the builders forced me to wonder 'If this move in interest rates -- back to some degree of normalcy in QE's twilight -- is negatively impacting what was reasserting itself as a key industry in the US economic recovery, then where will we be when the 30 year mortgage reaches 5%? In other words, if we can't handle this rate rise, what happens without any QE bond-buying and the Fed's exceptionally low rates?'

I recently had a conversation with economist John Blank, who also serves as Zacks Chief Equity Strategist, about these impacts and here's what he had to say about rising interest rates reducing housing demand:

'The only way housing demand is not affected is if the other affordability variables overwhelm the rise in interest rates. So expectations for income growth and job security have to go up, down payment terms have to fall, underwriting standards have to loosen, and lengths of amortization have to rise.

These things can happen. All too often we think that a rise in interest rates will just simply lower demand. That is only the case if all of these other variables do not move.'

Viewed this way, it makes a lot of sense what is going on in the market with homebuilder stocks. With the bond vigilantes finally free of the Fed's 'ownership' of the Treasury market, they are pricing-in the new levels of risk in fixed income and the economy.

And that means the onus is on the rest of the economy to improve to justify homebuilders earnings estimates and valuations. Until then, tread carefully in the names with dropping estimates and a Zacks Rank of #3 or worse. More of these may become #4's or #5's before they become #1's again.

Values may abound, but the full impact of rising rates may not be factored into all analyst estimates yet.

Kevin Cook is a Senior Stock Strategist for Zacks.com

D R HORTON INC (DHI): Free Stock Analysis Report

KB HOME (KBH): Free Stock Analysis Report

LENNAR CORP -A (LEN): Free Stock Analysis Report

PULTE GROUP ONC (PHM): Free Stock Analysis Report

RYLAND GRP INC (RYL): Free Stock Analysis Report

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