Investors should buy put options on Australian real estate and bank shares to profit from the likely bursting of the country’s housing market bubble, Morgan Stanley said.
Australian homes are about 40 percent overvalued and prices may retreat should unemployment rise or banks tighten lending, Gerard Minack, the firm’s head of global developed market strategy, wrote in a report dated Aug. 16. That means it’s a good bet to purchase option contacts that become more valuable as shares of Australian property developers and lenders fall, Morgan Stanley’s derivative strategists said in a separate report yesterday.
“The potential payout is significant,” Viktor Hjort, one of the Hong Kong-based co-authors of the note, said in an interview. “History shows when you have a major correction in the real estate market, the consequences are significant and affect everything across the economy.”
Hjort recommends buying over-the-counter puts on members of Morgan Stanley’s index of Australian banks, comprising the nation’s five biggest lenders by market value, and its Australian Real Estate Index, which includes Sydney-based Westfield Group, the world’s largest shopping-center owner. Because Minack said the probability of a near-term house-price collapse is low, Hjort recommends buying contracts that expire a year from now and have a strike price 20 percent below the security’s current level.
Sell Materials Puts
Investors can fund the trade by selling put contracts on raw-material producers as most of their sales come from abroad, meaning they’re less likely to retreat in an Australian housing recession, Hjort said. Melbourne-based BHP Billiton Ltd., the world’s largest mining company, makes up 36 percent of the Morgan Stanley commodity stock basket and gets 91 percent of its revenue from overseas.
Australian home prices rose at an annual rate of 18 percent in the second quarter, according data released by the Sydney-based Australian Bureau of Statistics on Aug. 4. That exceeded the median estimate for a 17 percent rise from a Bloomberg survey of economists.
Broad-based job losses, bank credit tightening and selling by loss-making middle-class landlords are most likely to prick the bubble, Sydney-based Minack, wrote in the Aug. 16 report.
The global credit crisis that began in the U.S. housing market has laden financial institutions globally with almost $1.8 trillion of losses and writedowns since 2007, according to data compiled by Bloomberg. That Australia was spared the worst of the crisis didn’t mean there was no housing bubble, just that the nation “dodged the prick,” said Minack, who predicted in 2008 that housing prices would fall 30 percent by 2010.
“Australia’s debt-fuelled housing market remains a major macro risk,” Minack said in the report. “I’m not persuaded by arguments that houses are sustainably priced; I’m not persuaded by the view that debt is not a problem; and I’m not persuaded that policy-makers could prevent collateral damage to banks.”
Australia’s housing bubble began to form around 2000, when economic growth and financial deregulation encouraged buyers to take on “increasingly imprudent amounts” of debt at low interest rates, according to the report.
Housing in the country is expensive both relative to history and to peer countries, Minack said. Overvaluation in Australian house prices are a cause of concern, Nobel Prize- winning economist Joseph Stiglitz said earlier this month.
House prices in Australian cities were 85 percent more expensive than the U.S. and about 40 percent higher than the average for the U.K., Canada, New Zealand and Ireland, based on the ratio of median house prices to median gross household income in the September 2009 quarter, Minack wrote in the report.
Options are derivatives that give the right though not the obligation to buy or sell a security at a set price on or before a certain date. Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will increase or decrease.