US markets are going through an interesting time. In the midst of heated election debates and a recovering economic environment, where does the once-great United States really stand? Opinions are divided.

At all times, markets fall into two cyclical environments, ‘vicious’ and ‘virtuous’. A vicious cycle is negative in nature and difficult to break. This is when structural detriments impact on an economy and restrict its prosperity. The Global Financial Crisis started with housing and ended in the collapse of just about every sector of almost every economy. House prices in America affected share prices in Europe, tourist dollars in Australia and the shipping corridors of Singapore. This vicious cycle reverberated to the furthest reaches of the global economy. National debt remains the crux of the problem, with European nations digging themselves deeper and deeper into sovereign liability.

So, at what point can we look towards a virtuous cycle? In many cases, what leads a fall often leads the recovery and America can now see the light at the end of the tunnel. Never one to be slow into action is Warren Buffett, who in 2011 pointed toward a recovery in all things housing and encouraged investors to take advantage of low housing prices and 30-year mortgage rates, in effect ‘shorting the dollar’. (see here)

But unlike 1991, 1992 and 2001, this housing recovery may be more long-winded. In the past, lower interest rates led to higher consumer spending, which, in turn, meant greater production, more jobs and ultimately, recovery.

The difference today is inventory. We have spoken in recent Trading Tutors newsletters of the foreclosure inventory and that it is likely being ‘squeezed’ to paint a brighter American investment picture in the face of upcoming elections. The fact of the matter is there is still a stockpile of housing inventory yet to be released to the market and this will prolong the weakness.

The real worry is what is still to come. Any GFC aftershocks, higher unemployment or decreased consumer spending could reinvigorate the foreclosure process, adding to the pressure on US banks and starting another vicious cycle of falling stock prices, currency pressure, earnings downgrades and repeated recession.

In 2011, housing accounted for just 38% of American household wealth. This was a huge decline from 2008 and well below the figure for Australia. And as Australian household wealth remains hugely leveraged to the housing sector, any serious decline in Australian house prices could trigger a vicious cycle here. America may on the verge of a new virtuous cycle but Australia remains over-leveraged to what many believe is a housing bubble.

Diversification is the name of the game. No one is safe.

Stay One Step Ahead,

Lachlan McPherson