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British Credit Crunch

Written By Brian Hicks

Posted February 9, 2008

It should come as no surprise that the global economy is falling apart. The Year of the Rat is upon us, threatening international tensions, natural and air disasters, and a turbulent stock market, says this report. Yep, when the Year of the Pig wraps up tonight, the Year of the Rat will be ushered in.

Coincidence or not, famous disasters fill the Year of the Rat history, including the Asian tsunami in 2004 and even the 1912 Titanic incident. In 1996, another Year of the Rat, 20 planes crashed, according to the report.

Better yet, “Kenny Lau, head of the small-cap sector at Credit Suisse, said the last three Rat years had all seen very strong stock market growth in Hong Kong. It grew 232 percent in 1972, 30 percent in 1984 and 18 percent in 1996. But he said high inflation — he predicted 5.1 percent in Hong Kong and 6.5 percent in the Chinese mainland — would provide a threat to economic growth and turbulent times were ahead.”

What will happen this time around? Who knows? But if economic tensions remain as elevated as they’ve been, nothing is out of the question.

Take a look at the UK, for instance.

UK Economy Pounded by Credit Crunch

The UK boasted an annual GDP growth rate of 2.5% for years, with some calling for 3% growth in 2007. But that was before the credit crunch, a crippling housing market, and a cutback in consumer spending, though. Worrisome, UK consumers depend more on credit that US consumers do, drowning the economist view of the UK economy into the River Thames.

It was November 2007 when the Bank of England’s chief economist warned that the effect of the credit crunch on banks may only be the tip of the iceberg.

But who didn’t see this coming?

In the early days of February 2007, we saw the beginnings of a sub-prime meltdown that would soon wreck the future of housing, easy credit, and people who bought homes they couldn’t afford. Now, months later, homebuilders and lenders are knee-deep in debt. And there’s no real chance for a housing turnaround until 2010, at the earliest.

But just as the U.S. has struggled for some control over sub-prime, Britain had to get aggressive or risk a tumultuous economic future. In the UK, more than 90% of all mortgages are adjustable-rate or floating-rate mortgages. More than 1.5 million homeowners are considered sub-prime, and another four million are seen as high risk because of imperfect credit histories.

In September 2007, UK ARM rates sat at 5.75%. Rates are now at 6% months later. And, as we’ve seen in the U.S., the ARM resets are having a negative effect on British consumers, sending the housing market into a U.S.-type tailspin.

On top of mortgage debt, British consumers owe $2.7 trillion on credit cards. Debt per capita is at a higher level even than for U.S. households. British household debt stands at 164% of disposable income, as compared to 138% in the United States. And research suggests that one in four people are either struggling with debt or feel that their debt is unmanageable.

It’s so bad that Citigroup announced it would cancel credit cards of more than 160,000 customers deemed to be “too risky.” In fact, according to reports, Citigroup has told those customers they have until the first week of March 2008 until the cards are terminated.

Is it any surprise that UK banks felt the pressure, too? They wrote off more than $18 billion in bad consumer debt last year alone. It was the sole reason I shorted shares of Northern Rock (NRK.L) at about 700, to watch it crash and burn under 120.


Northern Rock chart


Again, who didn’t see this coming?

Fortunately, economists don’t expect a housing bust like we’re dealing with in the United States. The UK, for instance, didn’t experience the boom we had in the U.S., so there may be fewer unsold homes to weigh on housing values.

But it doesn’t mean there won’t be pain. There’s still the fallout from falling home prices, and rising mortgage payments. The UK Financial Services Authority, for instance, says (as reported by the Wall Street Journal), “homeowners, whose monthly mortgage payments are resetting this year could face an increase of $411, at a time when they are already digesting a sharp rise in energy and food costs.”

And judging from the latest UK retail numbers, consumers are rethinking their spending habits in droves, as UK retail sales fell 0.4% in December from November. Worse, says a partner at retail property consultancy, Hartnell Taylor Cook:

“It comes as little surprise that the well-documented credit squeeze is the number one concern for UK retailers. Although the full impact has yet to become clear, it could put a lot of extra pressure on some businesses. The market is much less clear than it was this time last year, so there is a lot of confusion over how it will play out – particularly with regard to rents. The question is whether the credit squeeze will hit landlords or retailers hardest.”

“Although some areas of the market will probably always require stores where the physical product can be examined, such as fashion, firms in other sectors such as books and DVDs are already feeling the pinch of internet competition.”

It’s ugly out there, my friends.

How to Profit from the British Credit Crunch

Yep, the British economy is about as hot as the United States’ dollar these days. And one UK ETF is bearing much of the backlash, the iShares MSCI United Kingdom (EWU) ETF, which gained 30% in 2007.

EWU ETF chart

But as you can see in the EWU chart, it’s given back much of gains of 2007, with further downside coming. Your best bet may be to buy long-dated put options on EWU. Further crisis is imminent.

Ian L. Cooper

P.S. I just took 62% and 43% gains on Millennium in an average of eight days, a 3-day $3.36 gain on half of NutriSystem, and a six-day $4.11 gain on the second half. Get more information on Small Cap Trading Pit here.