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This Stock Market Could Collapse

By Tom Dyson, publisher, The Palm Beach Letter
Thursday, September 13, 2007

A friend is looking for work in London's financial industry...

"My timing is bad," he told me on the phone. "Most of the big banks have hiring freezes at the moment, so I haven't had much luck. A strange thing happened last month though..."

"I used to work at Barclays Capital. Three weeks ago, I got a call out of the blue from one of my old bosses. He said his team is financing a new subprime lending business in Madrid, and he wanted me to apply for the COO position."

"I was amazed that they came looking for me... especially in this environment. So I went to a couple of interviews and everything seemed to be going pretty well. They asked me to come in for one final meeting... they said they wanted to offer me the job and this final meeting was just a formality. Anyway, as I'm walking to the train station, I get a phone call. It's my old boss. He tells me Barclays have pulled their financing and the whole gig is off."

Spain has the largest property bubble in the world. Since 1996, Spanish median house prices, after adjusting for inflation, have risen 130%. That's the third-largest increase among OECD economies – the so-called "developed" economies. (Ireland and Britain are No. 1 and 2, respectively). However, since 2000, Spanish house prices have doubled. That's more than any other country in the western hemisphere... even Ireland or the U.K.

Not only are prices extremely high... they've become totally unaffordable. The house price-to-income ratio is one measure this. In Spain, the ratio is more than seven. In other words, on average, in Spain, people's houses are worth seven times their annual pre-tax income.

Compare this to the U.S., where the median nation household income for 2006 was $48,201, and the median house price was $212,000... a ratio of 4.5.

The supply of houses in Spain has also gone crazy. Last year, 800,000 houses were under construction in Spain... that's more than in Italy, Germany, and France combined... and just less than half the houses under construction in the U.S. (The U.S. population is six times bigger than Spain's.)

In the U.S., the construction industry makes up 8% of the total labor force. In Spain, 13% of the labor force works in construction and construction investment measures 18% of Spanish GDP, up from 11% in 1998.

In America, when the consumer gets into trouble, the Fed simply cuts interest rates and stimulates the economy with cheap cash. Spain can't do this. The European bureaucrats in Brussels control Spanish interest rates. Rates are set mainly to German and French considerations. This is why Spanish interest rates fell from 12% in 1999, when they still used the peseta as the official currency, to 2% in 2005, under the European Central Bank and the euro currency.

Now, European interest rates are rising. They're up to 4% from 2% 18 months ago.

In America, many people think the huge number of adjustable-rate mortgages issued by the subprime lenders over the past few years could bring down the consumer. But in the U.S., only 50% of mortgages come with adjustable rates. In Spain, 90% of mortgages are issued with adjustable rates. So the Spanish consumer is much more sensitive to rate hikes than the American consumer.

In sum, I think the Spanish economy is in big trouble. And because the Spanish central bank has no power to cut interest rates, I think house prices in Spain and the Spanish stock market are going to experience heavy falls.

I first voiced this opinion on June 5, 2007, with my column called "Spain Is in Big Trouble." At the time, the Spanish stock index – the IBEX35 – was trading above 15,300. It's now at 13,900... a 10% decline in three months.

My friend confirms that bankers are finally pulling money out of Spain's housing market, I suspect the next leg down is imminent...

Good investing,


Market Notes


Enrique Banuelos, one of Spain's most colorful – and richest – entrepreneurs runs Astroc Mediterraneo, a large Spanish homebuilding and land development company.

Baneulos took his company public on May 23, 2006. As you can see from the chart, shares opened at 6.4 euros. By February 26, 2007 – just nine months later – the same shares were worth 72 euros... a 1,025% gain.

That's when the crash came. In March and April, Astroc's shares fell 90%. Today, you can buy shares in Banuelos' company for 10 euros.

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