Will Housing Bottom in … 2011?

That is the likely scenario according to a report published on Tuesday by mortgage insurer PMI Group, according to which 28 of the country's 50 largest metropolitan areas face high odds of lower home prices in the first quarter of 2011 (vs. now).

Unemployment takes the relay baton
The areas with the worst odds of home price drops are in states that were in the eye of the housing bubble, including California and Florida, but the report notes that the increase in risk "is now largely being driven by rising unemployment and foreclosure rates."

PMI's forecast contradicts Yale economist and housing guru Robert Shiller. Last week, commenting on a lower-than-expected drop in the Case-Shiller home price index in the month of April, he said: "My guess would be that home prices are going to level off -- they're not going to keep falling." Still, he cautioned "it's hard to predict" a speculative market. So, who is correct?

A sector at risk: Consumer discretionary
Although Shiller is well-informed and appropriately skeptical, I think we may witness something closer to PMI's scenario due to persistent high unemployment. If that turns out to be the case, it isn't good news for companies that rely heavily on a buoyant U.S. consumer, particularly those that look somewhat expensive:

Company

Forward P/E

YTD Price Return

Amazon.com (Nasdaq: AMZN  )

44.5

47.5%

Sears Holdings (Nasdaq: SHLD  )

30.0

53.7%

Marriott (NYSE: MAR  )

21.7

1.4%

Abercrombie & Fitch (NYSE: ANF  )

19.0

1.3%

Starbucks (Nasdaq: SBUX  )

17.0

37.1%

Home Depot (NYSE: HD  )

16.7

(2.7%)

Yum! Brands (NYSE: YUM  )

16.1

9.5%

Source: Capital IQ, author's calculations.
Note that I do not have a view on whether these stocks are overvalued -- they were selected systematically because they are statistically expensive based on a single metric.

Although economists can argue about the magnitude of the "wealth effect" according to which changes in home values affect consumption, I think there is little doubt that further home price drops would affect consumer confidence and, ultimately, the level of consumption. In that environment, defensive sectors (health care and consumer staples), which lagged many other sectors during the second-quarter rally, may find favor again. 

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Alex Dumortier, CFA has no beneficial interest in in any of the companies mentioned in this article. Amazon.com and Starbucks are Motley Fool Stock Advisor selections. The Home Depot, Starbucks, and Sears Holdings are Motley Fool Inside Value picks. The Fool owns shares of Starbucks. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (67)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 09, 2009, at 1:39 PM, plange01 wrote:

    with the US just over 6 months into a depression expect housing prices to drop at least 3-5 more years...

  • Report this Comment On July 09, 2009, at 6:08 PM, Dannysea wrote:

    Working in the foreclosure market for the past 15 years, without question, PMI has it. In our county we see over 200-ish foreclosures a week on courthouse steps, but end up seeing about 2 dozen making it to the Realtor hands. Just in the past several weeks this Administration has now allowed renters with a lease to stay in that dwelling until same is complete; no stipulation whether occupant pays, etc.That was one of the last main flows of foreclosures making it to the market for resale.

    Previously, owner-occupant properties could pretty well claim any hardship; they were rewarded with their residence at about a third of their original monthly payment. These have been refailing almost 2 out of 3 (62%,) and are destined for foreclosure again. (Expecting this to be 80-95% failure 2 years from now.)

    Best-case scenario: this policy is replaced in the next couple years to allow free market handling, we will see a spill-over of 7-10 years.

    Remember, we are now experiencing 12.5% that are 30-days or more behind in their payments.

  • Report this Comment On July 09, 2009, at 7:24 PM, xetn wrote:

    The longer the administration keeps forestalling the correction, the longer the process will take. Nobody knows how long it will take for prices to bottom, and you can bet that some areas will bottom quicker than others. The market is not some thing that can be reduced to a mathematical formula, it is billions of individual transactions between buyers and sellers and no amount of government intervention can change that.

    All the government interference does is prolong the adjustments.

  • Report this Comment On July 09, 2009, at 8:24 PM, jesse2159 wrote:

    Housing prices won't go down forever, any more than they were expected to go up forever. Unless of course you're Merrill Lynch, who, announced today that they will be selling $87 billion in junk, eh,...slices of real estate sub-prime mortgages in bundles rated AAA (they were rated by Moody's in 2006, ...a small omission)

    OK, who's crazy. Didn't this lead to the death of Lehmans and life support for Citi?

    Home prices will level off when investment companies level with the public. Now don't go holding your breath waiting for that to happen.

  • Report this Comment On July 10, 2009, at 1:47 AM, bobs111 wrote:

    Housing prices and stock prices will continue to be unpredictable and trending lower untill Uncle stops screwing around with these markets.

  • Report this Comment On July 10, 2009, at 5:50 AM, memoandstitch wrote:

    The government should let home prices fall. Cheaper homes = more affordable for consumers = less debt = more spending.

    Just foreclose every home and let the prices go way down. Houses aren't going anywhere (they don't have legs). People will find new homes at cheaper prices. The only ones losing are the banks but the government has implicitly pledged to prop them up anyway.

  • Report this Comment On July 10, 2009, at 6:37 AM, speckledbrain wrote:

    The public has been confused by unscrupulous psychologists who have fooled the public into believing that a home is the same thing as a house. The word 'HOME'makesw us feel warm and fuzzy. A house is a "black-hole' down which ones pours endless amounts of money. So buy a house and make it a home. In the words of Edgar Guest, "It takes a heap of living to make a house a home." And isn't it strange that we now build prospereeity through buying and in the past we built prosperity through manufacturing and building. Reall STRANGE alteration.

  • Report this Comment On July 10, 2009, at 11:22 AM, MADACASTO wrote:

    I have 12 years in the real estate profession in multiple capacities, including residential sales (resale and new construction), commercial management and leasing. I'll flip a coin and tell you where we'll be next year at this time, and I still have exactly a 50% chance of being wrong. Throw this report/commentary in the garbage because anybody predicting 2 years out needs their head extracted from an unmentionable orifice of the nether region.

  • Report this Comment On July 10, 2009, at 3:56 PM, clanza875 wrote:

    If wages are in line with housing values in 2011 then yes...

  • Report this Comment On July 13, 2009, at 7:25 AM, GRAHAMDOWNUNDER wrote:

    America must stop ( or servely limit )the construction of dwellings ,there is a glut of housing from oversupply . This market will keep heading down while there are more sellers than buyers .It will take about 3 -7 years for this to happen in most areas. If new construction is not limited it may take 15 plus years . Rents will have to rise to make investing in property wothwile . With an oversupply rents will not increase and investors will not buy,

    Sure there are areas that will be an exception but the general rule is stay out because you will buy cheeper or for the same price over the next few years.

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