Given recent rallies in financial markets, it is looking less likely that the implosion in the U.S. housing market will seriously impact the U.S. economy and stock market. But we might remain concerned about risks elsewhere, particularly in Spain.
House prices in this European country are in an enormous bubble. Over the past ten years, they have soared 200% (according to the Ministerio de Vivienda). By comparison, U.S. house prices have climbed a “mere” 80% over the same 10 years.
Recently, signs of declining house prices have emerged in Spain. If the slide deepens, the impact on the domestic banking system could be serious since Spanish commercial banks have high loan exposures to real estate.
In Europe, monetary policy is set by the European Central Bank, and the latter will not likely be moving to ease any time soon (the cyclical downturn is not yet advanced in Europe). Therefore, short selling the iShares MSCI Spain Index (EWP), on a currency hedged basis, looks like an interesting speculation.
More conservative investors might want to play the relative trend in Spanish and U.S. stock markets. That is, a pairs trade -- short the iShares MSCI Spain Index and long the S&P 500 Depositary Receipts (SPY) exchange traded fund, could be profitable with less risk. Rationales for this trade include: i) the Federal Reserve is ahead of its European counterpart in the easing cycle, and ii) professional money managers are substantially underweight U.S. securities relative to European.