In the wake of my last post about whether USD assets and Treasury paper would remain safe haven and diversifiers in the next global downturn (see Will diversified portfolios be doomed in the next recession), I received a number of questions as to what investors should avoid. There is an obvious answer to that question.
Call them the new Fragile Five.
The pro-cyclical Fragile Five
Loomis Sayles made the case for these countries to be the New Fragile Five, based on unsustainable real estate bubbles:
Cracks are starting to appear in five highly leveraged economies: Canada, Australia, Norway, Sweden and New Zealand. For several years following the global financial crisis, these five countries all shared a common theme—a multi-year housing boom, fueled by low interest rates, which resulted in very elevated levels of household debt.
This boom is starting to dissipate in all five markets. House prices have largely reversed course, be it slowing appreciation or outright decline. Moreover, this is occurring even as interest rates remain at or near record lows and labor markets continue to be robust. Importantly, this is a correction that many thought could not occur given the otherwise strong economic growth backdrop in these countries. But we take a long-term view of house prices, and began highlighting affordability problems in these markets several years ago.
Here in Vancouver, I can personally attest to the insanity of local property prices. As an example, here is the cheapest listing of a single detached house that I could find. You can have this beauty for about USD 1 million!
Oh, don`t miss the view from the back.
In addition to highly elevated property prices, the New Fragile Five also suffers from the doubly pro-cyclical characteristic of being resource based economies. If the Chinese economy were to slow significantly, these economies would also be hurt by plunging commodity prices. As the chart below shows, these currencies are highly correlated to either oil prices. or the CRB Index, which are expected to fall in a pro-cyclical fashion during a global downturn.
Falling property price AND falling commodities in commodity sensitive economies? Ouch! As a Canadian resident, I will be maintaining a USD position in my portfolio for precautionary purposes.