Is global financial crisis closer than expected?

Since the last recession which was crystallized by financial crisis in 2008, the US and global economies have experienced sustained growth. Major market indicators such as S&P 500, NASDAQ, and Dow Jones have gained in excess of 280%, 400%, and 250% respectively. The number of stock market analysts predicting recession is increasing by the day. At the very least, there is a consensus among market analysts that the global economy is poised for another financial crisis, however, predicted timing varies widely. Some analysts called for recession in 2016, some strongly believe recession will occur in 2018, and others predict a bullish trend in the stock market will continue through 2020 before recession can occur.

In March 2018, the US economy's bullish trend entered its ninth year, making it one of the longest-gaining streaks in the history of the US economy. While there are divergent views among analysts with respect to when global financial crisis may occur, there seems to be consensus that financial crisis is inevitable.

Various factors led to the 2008 global financial crisis, such as the explosion of household debt, subprime mortgages, economic inequality, pervasive speculative trading, and so on. While it may be too early to determine or ascertain factors that would contribute to the next financial crisis, it is worthwhile to analyze issues and factors that may signal one.

Yield Curve

An early signal of an impending global financial crisis is an inverted yield curve. A yield curve becomes inverted when the long-term Treasury bond yield is lower than the short-term Treasury bond yield. This is a strong prediction of an impending recession. 

As of 9 March 2018, the yield curve is normal with positive slope. This curve indicates that investors still have strong confidence in the US and global economy. However, as soon as this curve flattens, it might be a signal of an impending market crash.

Household/Public Debt

The size of household debt is another critical issue that must be watched with keen interest. China saw its household-debt-to-GDP rise to 46.80% in the second quarter of 2017 from 45.50% in the first. This ratio is at an all-time high compared to the 10-year average of 28.41%. Currently, household debt in the United States is around 78.20% compared to the average of 56.55% recorded over 65 years. This ratio—which hit 95.50% in 2008—provided a clear signal prior to the financial crisis as several people became bankrupt and lost their homes as soon as policy tightening began due to excessive household debt. It might be safe to set a benchmark of 90% for this ratio, a level at which investors should proceed with caution.

Commodities Prices

The price of commodities such as crude oil, cocoa, gold, platinum, diamonds, et al, is another potential warning sign for financial crisis. Bloomberg Commodity Index (BCOM), which tracks 22 different commodities, is currently trading at 87.07 compared to 233.03 on 1 April 2008. The commodities bubble during this period contributed to the financial crisis due to increased irrational behavior among investors. However, it is very difficult to ascertain causality between economic boom and commodities bubble. Despite significant gains recorded in the global economy across various sectors, commodities price failed to experience similar growth. The Bloomberg Commodity Index is currently trading at a 15-year low of 87.02, lower than the 109.78 reached in 2009 during the global financial crisis. With the commodity index trading lower since 2016, income level and spending power of developing countries whose economic mainstay is commodity is seriously impaired. This, in turn, would have an adverse effect on their ability to service foreign or external debt, which is increasing at an alarming rate. The low level at which the Bloomberg Commodity Index is trading might give credence to the projection that the next financial crisis may occur within 12–18 months.

Stocks Valuation

Since dropping from a level of 16,000 to 10,000 during the peak of the 2008 financial crisis, Dow Jones Industrial Average (DJIA) has gained 250% to reach 24,979. Since 2009, the US stock market has continued its bullish trend, leading the market to a record nine-year gaining streak in March 2018. With the exception of minor corrections that occurred during that time, the streak has not shown any sign of losing momentum. Most analysts opine that this gain will continue throughout the year 2018 and projected that market index may hit 30,000 before the end of the year.

Dow Jones Industrial Average

Similarly, Morgan Stanley Capital International Index (MSCI Index), which is a proxy for global market index, showed patterns similar to the US stock market. The MSCI index dropped from USD 36.87 to USD 16.55 during the 2008 financial crisis, then grew significantly to reach the current level of USD 155.  Across the globe, investors’ confidence level is at an unprecedented high level. This high level of consumer confidence and strong economic fundamentals may continue to propel stock markets and economies northward.

Conclusion

The issues explored would play significant roles in determining when the next financial crisis is likely to occur. However, other factors are germane to this discourse and worth considering, like American government policies and  international/global relations. Current high levels of consumer confidence may sustain investors’ irrational behaviors. The next financial crisis may be closer than we thought as crisis usually happens when it is least expected. Investors need to be attentive to and cautious of these indicators so they are not caught off guard.

About the Author

Tunji Adeniran, CFA, is an accounting graduate of Brock University in St Catharines, Canada. He is a senior Treasury analyst with First Ontario Credit Union in Canada.