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 |
44.5 |
47.5% |
|
Sears Holdings |
30.0 |
53.7% |
|
Marriott |
21.7 |
1.4% |
|
Abercrombie & Fitch |
19.0 |
1.3% |
|
Starbucks |
17.0 |
37.1% |
|
Home Depot |
16.7 |
(2.7%) |
|
Yum! Brands |
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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