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. 

Confused by this market? Looking for specific stock names? Morgan Housel highlights three high-quality companies that are still cheap.

More Foolishness:

Take a hint from Warren Buffett's recent investment in preferred shares with fat yields: In this market, dividends will be a big part of future returns. The team at Motley Fool Income Investor can show you how to build -- and manage -- a portfolio of stocks that pay a growing dividend. To find out their top five recommendations for new money now, take advantage of a 30-day free trial today.

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.