Another Housing Bubble to Short

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.

Comments

[Uncle Bill:]

That's the most ridiculous first sentence I've ever read on this website. Please explain how the "pairs trade" could possibly be profitable with "less risk"?

2007 Oct 17 08:35 AM

[Larry MacDo...:]

To see how pairs trading can lower risk and increase the odds of a profit (albeit smaller), see the following links:

en.wikipedia.org/wiki/...
“The pairs trade helps to hedge sector- and market-risk.”

www.valuestockreports....
“By using ETFs to construct pairs trades, a portion of specific risk can be hedged and the odds of profit can likely be increased.”

2007 Oct 19 06:28 PM

[CJ:]

This is interesting. But how about buying structuring a pairs trade where you buy FEZ and sell EWP?

2007 Oct 17 07:26 PM

[CJ:]

This is interesting. But how about buying structuring a pairs trade where you buy FEZ and sell EWP?

2007 Oct 17 07:26 PM

[StockSuspic...:]

Larry MacDonald: Aren't you just some freelancer who juggles a few bucks on your own, in the market, and sells noncommital articles, like this one? "...might remain concerned..." "...could be serious..." "...might want to play..." "...looks like an interesting speculation." Good grief.

2007 Oct 18 10:26 AM

[Larry MacDo...:]

Larry MacDonald is an economist who has been writing about financial markets since 1995. A noncommittal statement would leave the author leeway to wiggle out of his or her advice. Don’t see how that applies here. If in a year or two from now Spanish stocks are higher in absolute terms (for aggressive risk accounts) or relative to US stocks (for less aggressive accounts), we will clearly be able to say he was wrong.

2007 Oct 19 06:56 PM