This article aims to help you to understand, monitor, trade and invest in the next global financial crisis.  It’s what we do ourselves continuously as well as helping small independent investors with ideas to mitigate potential medium to long term losses in portfolios.

The 4 Pillars of Future Global Financial Crises…

• Debt.

• Central Banks.

• Business Change & Automation (The 4th Industrial Revolution / The ‘Green Revolution’)

• Geopolitics.

Debt, Trust, and Financial Wizardry

• Global debt is worse now than 2008. In fact, global debt levels have never been higher.$17 trillion worth of debt is carrying negative yields. Even back in 2018 before the extreme acceleration of central bank money printing due to Covid, total debt in the world economy reached 318% of GDP.

• Banks are bigger and more interconnected than ever before.

• CHINA & Debt: China is not a safe haven for capital, and nor will it become one. Its enormous debt overhang and need for endless money printing programmes to give the populous, something, anything to do, not to mention that there are many people who consider the CCP to be overseeing a criminal state, doesn’t exactly inspire the confidence of investors in a crisis.In fact, China may well be ground zero for the next crisis due to its enormous debt burdens.

• The so-called “PIIGS” countries debt loads have not gone away and are still more likely to be the "at risk" soveriegn debt countries.

• Italian banking loans are known to be in dire straights, and sovereign debt is high. Various iterations of Italian Populist governments look set on a collision course with the EU and have a massive debt pile. The magnitude of this Italian debt means the EU Bailout Fund can’t rescue Italy. The ECB can’t rescue Italy as it could do with other smaller countries.

• Debt diversity – new ‘subprimes’?. In the US, Student loans exceed $1.6 trillion by value and 11% are in default. Car loans exceed $1.1 trillion. $1 trillion in US credit card debt.

• Collateralised loan obligations (CLOs) are now popular again, and, ‘low documentation’ loans are back in the US. Those types of loans are poorly underwritten so could be described as a kind of new “subprime”.

• Credit ratings are now much lower than in the past – more than 50% of investment-grade bonds are now rated “BBB” (the lowest rung in the category)

• The Bond Market Bubble. The canary in the coal mine? Low interest rates have created a heavily indebted world. A bond market crash would drive up interest rates creating serious problems. The bond market is a lot bigger than the stock market. It matters.

• Corporate bankruptcies. There is one area where the US is showing considerable growth. August 2019 figures from the American Bankruptcy Institute show a 29% year-on-year increase, the tenth consecutive month of higher failures. Looking at this another way, the delinquency rate on US commercial and industrial loans is still just 1.6%, but it has doubled from its late 2014 low of 0.72%, and that at a time when bond yields are plunging, interest rates anchored near zero and the US economy allegedly doing well. US corporate loan delinquency rate is rising sharply (albeit from a very low base)12% of listed companies in developed  countries can’t pay debts out of profits

The Central Banks (FIAT Currency Destruction & Artificial Asset Inflation)

• Interest rates globally, can’t be lowered any further to stimulate growth.|

• Quantitative Tightening – QT (raising interest rates) could lead to instability around the world, particularly in Emerging Markets. QT will cause government bond yields to rise which will provide an attractive alternative to equities, lowering stock prices. Before Coronavirus turned up, this was a risk. Suffice to say. this risk has subsided for now, but when the recovery comes combined with inflation, quantitative tightening will be a bigger risk as a result.

• Bailout/Rescue fatigue. Everyone was rescued during Europe’s sovereign debt crisis. The risk now is that our bailout institutions and rescue funds are either used up, too small, or misaligned. Bank of International Settlements Chief Economist Claudio Borio explained it like this: “There is little left in the medicine chest to nurse the patient back to health or care for him in case of a relapse.” Respected Financial commentator, Ambrose Evans-Pritchard had a similar take: “the ECB has exhausted its monetary powder”. Instead of standing at the ready, our bailout institutions might be the very ones to trigger a stock market crash. JP Morgan analysts are warning about a “great liquidity crisis” as central banks reverse loose monetary policy. That’s because they haven’t just been helping borrowers along with low interest rates. They’ve also been buying copious amounts of debt.
  The day the buying stops, the true market price of bonds and other assets will be revealed.

• Record low central bank interest rates have been rolled out globally in unison for the first time in history, along with record levels of money printing out of thin air… A.K.A. Quantitative Easing. This has ‘artificially’ inflated assets, property, and stock markets rather than kick-starting the real economy.
  Central banks are in a race to the bottom devaluing their currencies against each other eroding trust, erecting trade barriers, and stunting growth. Currencies issued by today’s governments lose roughly half their purchasing power, roughly every decade!

• EU: ECB Balance Sheet All Assets (EBBSTOTA). The ECB got spooked by the 2012 – 2014 dip in the markets and raised its balance sheet assets to $4.7 Trillion by 2018. Any sign of Eurozone weakness will of course, invoke exactly the same response. The question will be “How long can the ECB kick the can down the road before the debt bomb explodes?

• USA: The Federal Reserve printed $400 billion late last year (2019), before all the subsequent money printing in response to the pandemic, in a move to contain an explosion at the base of the interbank lending system, the ‘repo market‘. On top of that, it cut interest rates to zero (ZIRP) in an attempt to combat the financial market coronavirus crash.

• CHINA: Currency pegs & manipulation. The value of the Chinese yuan is fixed, or pegged, to a basket of the other major currencies – predominantly the US dollar. In this way, China has to share all of those other economies’ problems. It automatically imports them by printing money to maintain the peg whenever the exchange rates try to move.

• Switzerland has been a safe haven for capital for a long time. The Swiss franc is ranked as a top safe-haven currency, like the yen. This creates serious problems for the Swiss economy during crises. Its currency regularly spikes during a crisis as wealthy people run for cover to one of the most stable nations on earth. This spike harms the Swiss export industry, just when their sales would dry up due to whatever had caused the crisis in the first place. It’s another example of the double whammy which strikes countries whose currencies rally during a crisis. Sick of this negative feedback loop, the Swiss decided to manipulate their currency too. Due to the size of the country’s economy relative to the demand for a safe haven, the Swiss central bank (SNB) has had to intervene in a far more intensive way than other countries. In short, the Swiss franc is not allowed to reflect the strength or weakness of the Swiss economy. It reflects the demand for a safe haven, and the central banks’ attempts to stop the consequences of this demand, instead.

• UK: The UK may be in a strong position now. Of the top five economies, the UK is the only one with a free-floating exchange rate that reflects its own economic prospects. All others’ currencies are at the whim of events in global markets, international trade, financial speculation and central economic planning.
  Just as Switzerland is currently one of the world’s obvious safe havens for capital from international investors, the UK could soon be too.

• There is risk to EM if we see a developed markets downturn, otherwise long term growth for EM. All Emerging Markets borrow in US dollars. The dollar may spike as a flight to safety if a global downturn begins. This creates a risk of future EM defaults if a downturn starts to gather pace. (If the US dollar strengthens, emerging market dollar debts get more expensive.) If there is a downturn I would be tempted to sell out of EM investments, or at least reduce exposure.
  
  However, Emerging Markets can have good growth prospects based on a weakening US dollar. Non-US equities will fare better because a weak dollar amounts to a transfer of wealth from the US to the rest of the world. Emerging markets will do particularly well in this scenario, obviously the commodity producers, but maybe others too, especially Asia once Covid-19 is finally behind us. They are also where we can find value.

• Claim: If US markets crash, your already unloved EM value can retain its value better than cash, gold, or some other protective asset.

Not necessarily true. Historically, emerging markets have failed to offer any resistance when US markets crash. They’ve had a beta of around 1 with American markets. That is to say they fall broadly the same amount as the US. Some fall more, some less, but overall, emerging markets have not tended to offer anti-correlation when you need it most.

In the last bear market, during the Great Recession, the Vanguard 500 Index Investor fund (VFINX) fell 55%. The Vanguard Emerging Markets Stock Index fund (VEIEX) tumbled 61%.

• Global Property Crash risk. Since the financial crisis in 2008 record-low interest rates and unprecedented central bank money printing around the world have artificially inflated global housing markets, in particular, London, Canada, and Australia. Watch out for creeping regulatory powers (UK Mortgage Market Review for example). There has been an up-market London Property slowdown since mid to late 2014. Foreign investors are starting to get their fingers burnt with restrictions imposed by the UK government and transaction volumes have fallen sharply.In 2008, 70% of new Chinese homes were sold to first-time buyers. Now that has shifted into reverse. 69% of new homes were sold as investment properties.UK government rule changes for Buy To Let investors, foreign and domestic has had a demand-side dampening effect on the property market, but regardless, prices are still too high, and the system needs to support them or else all hell will break loose. So, the solution has been to accelerate infrastructure spending and to lend more. This is an attempt to sustain the unsustainable. The result will be capital flight from property.

4th Industrial Revolution & Trends & Business Performance

• Flotations & IPO’s. New company flotations are starting to wither after issuance or being pulled before launch (E.g., Saudi Aramco; WeWork)

• The public issuance of unprofitable businesses now exceeds the value listed in 1999

• Automation & AI. Transfer of jobs from humans to machines mean job losses and job losses mean recession. There are about 3.5 million truck drivers in America today. Driving a truck is the most popular job in more than half of U.S. states. Today, the technology to completely replace 90% or more of these jobs is already available. Whilst the transition to driverless technology will take a while, the direction of travel seems pretty clear. A lot of jobs are going to be lost due to this technology trend. Google is leading the way on this. GPS, 5G wireless, LIDAR technology, and other innovations will soon put millions and millions of truckers out of work. And as those lights go out, the consequences to America’s political union will be perilous. Robotics will destroy millions of manufacturing jobs, and AI will eliminate the need for millions of customer service jobs

• Online buying trends are taking over from retail buying. Investment bank UBS estimates another 75,000 retail stores across America could be lost by 2026.

• USA: A leading Indicator is the US Initial Jobless Claims SA INJCJC Index. If this starts trending up when viewing over the previous ten years then it points towards recession.
  
  YOU CAN’T HAVE A RECESSION WITHOUT PEOPLE LOOSING THEIR JOBS.

• USA: US Yield Curve Spread (The difference between banks borrowing and lending rate) When this goes negative then turns positive, it’s a leading indicator of recession. Historically it’s been 1-2 years after the dip that a recession occurs. If this is the case, the next recession could be around 2020

• USA: FED EX International Business delivery chart is another leading indicator. This was down end of 2018.

• Cryptocurrencies. Back in 1999, Nobel Prize-Winning Economist Milton Friedman forecast how the internet will fuse with a new monetary system…“One thing that’s missing but will soon be developed is a reliable e-cash, a method whereby on the internet you can transfer funds from A to B without A knowing B or B knowing A — the way I can take a $20 bill and hand it over to you, and you may get that without knowing who I am.”This is now a reality in cryptocurrency, and although it’s still early days for crypto, it is almost certain that it will emerge as a new monetary system with major corporations increasingly adopting crypto, along with central banks talking about how they will use it.  Today an estimated 90% of the younger generation prefers owning digital currencies to gold, according to Bloomberg. Generation Z are increasingly anti-establishment and the opportunity provided by cyrpto and its underlying technology… blockchain, to bypass ‘the system’  looks like a marriage made in heaven…

What Bitcoin and blockchain essentially do is allow regular people like you and me to have new ways of conducting commerce, which route AROUND large companies and big governments — because those entities are expensive, and simply can’t be trusted.

Geopolitical Stress & Failure, War, Terrorism

• Support is still increasing for Socialism Despite socialist economic failures. Argentina was bailed out by the IMF to the tune of $50 Billion. The biggest in its history. Other South American states, E.g. Venezuela are failing under socialist policies.

• Populism… the West’s ‘Arab Spring’ is growing and looks set to continue. Mass migrations to the West are causing chaos and resentment, fueling a range of growing reactionary movements. An increased level of Islamic terrorism in the West is just throwing fuel onto this fire. Unless Western governments bring migration under control in the next few years, conflict will likely be the result.

• The EU, Eurozone economies, and the Euro project itself are showing signs of severe stress. Multiple nations in Eastern and Southern Europe have either suffered economic recession, or, are in opposition to the EU. We could see countries following the UK out of the EU and Euro. This does not seem to be a truly sustainable situation for the EU, although they will likely trundle along for quite some time yet.

The world’s big buyers are getting poorer…

• The Saudis are seeing collapsing oil revenues.

• The sanctioned Russian economy is a mess. Russia is increasingly under attack from the Anglo-sphere (NATO) and will entrench more and more with Iran and China as a result.

• North Africa, Africa, and the middle east regions are experiencing high levels of destabilization and escalating violence. The region is mired with increasing Islamist terror.

• The Chinese slowdown, in general, presents contagion risks in China and globally e.g. Australia. Municipal Chinese banks are heavily indebted and crazy infrastructure projects have exposed Chinese banks as well as the likes of HSBC. Crackdown on corruption in China means that one of the traditional routes to wealth there isn’t working as well as it did.

• Turkey & Emerging Markets. Turkish Lira collapsed recently losing 80% of its value. Turkeys debt is rated as ‘Junk’ status. Turkey could yet turn out to be the largest Emerging Market default in history.

• The USA doesn’t actually have its own exchange rate anymore. When the Federal Reserve sets interest rates, it is effectively setting interest rates for much of the global economy, and so cannot act purely in the interests of the US economy when it hikes or cuts rates – it has to consider everybody using USDs.

• JAPAN: Mrs Watanabe. The Japanese export a great deal of capital – ie, they invest heavily in other countries. When there’s a crisis in international investment markets, the yen tends to rally as Japanese investors – known as Mrs Watanabe – bring their money back home for safety. This significantly strengthens the yen, which brings deflation home and makes economic shocks worse. Also, due to the Japanese low-interest rate ‘carry trade’, the Yen exchange rate isn’t only driven by the prospects of the Japanese economy. Yet another major currency, working in favour of globalism, and the nation it is meant to be serving.

• Germany entered recession in the early part of 2020, and they don’t have their own currency with which to react. Germany gave up the Deutschmark for the euro, and so their exchange rate reflects the entire euro zone’s prospects instead of just Germany’s.

Trading & Investing in the Next Global Financial Crisis

REITs are a decent candidate asset class t hedge a portfolio in case of market crash. Whilst they don't have the reputation for long term growth to the same extent as equities, it was found to be a component in one of the portfoliocharts.com portfolio that was found to increase the longevity of the portfolio compared to other portfolios without the REIT element/allocation.

• REITs outperformed the US Tech NASDAQ 100 after the Great Financial Crash 2008. In a crash, REITs are part of the flight to safety. 

• When interest rates rise, REITS perform much better than stocks which tend suffer under the tightening conditions of rate rises:

• REITS were the best performing asset class from 1998 to 2018!

Hedging with REITS = When markets fall, REITs tend to do well as they are viewed as safe investments returning a safe yield. They form a component of the assets that are bought in the 'flight to safety' = when the pandemic is finally behind us the tech stocks that did well directly as a consequence, will probably start to struggle. Peleton is a good example of this. REIT's don'rt have this problem.

Debt & Risk Taking – Recession/Bear Market Indicators

GLOBAL DERIVATIVES RISK

So, we have our leveraged debt charts above, but there is a wider ‘Systemic’ global risk factor… Total Global Derivatives. The global derivatives total is estimated at somewhere between $1 Quadrillion to $2.4 Quadrillion. This is an unimaginable sum of money. I sometimes think of it in the same way as that US debt clock, a financial black hole that the entire global financial system will eventually get sucked into. 2020 saw a derivates surge indicating the wider systemIC risk is increasing.

• BANK OF INTERNATIONAL SETTLEMENTS – GLOBAL DERIVATES

SPACS

The annual value of announced speculative SPAC mergers to take companies public, exploded in 2020 to $150 Billion and in 2021 already has surpassed the 2020 level by about another $20 Billion. There is a lot of risk-taking going around, and this seems to be concentrated in the US.

STUDENT DEBT JUBILEE?

You might think “It’s just student debt” but US student debt is at similar levels to 2008 US subprime debt and a significant proportion of the debt is bad debt. Click here (to view in new tab)

Democrats in the US are trying to push through a student debt Jubilee of some form. Even if they don’t get it, could this be a green light for the pandemic to be used as an excuse by the holders of this massive debt pile to effect their own debt jubilee? If students are struggling due to job losses and incur more debt as a result…. why pay it back? … those who are diligently paying will think… “should I keep repaying this? If others are deliberately defaulting and the government may cancel it anyway there is no point in me keeping the payments up”?

US Housing/Property Mortgage Debt & Vacancy Rate

Reports are coming out of high numbers of mortgage defaults in the US … Biden will kick the can down the road but 2022 could see huge default levels and a crash in the US housing market. Similar reports are being made for commercial property defaults.

• CLICK HERE for a real measure of HPI in the US which shows the increase in actual recorded prices for buying the same property from the last time it was sold and is considered a more accurate measure than other HPI indices. (clearly what you can see is a bubble much bigger than the previous property bubble before the GFC 2008).

• CLICK HERE for a breakdown by US State

In 2020 “Homeowner Vacancy rate for the US” (CLICK HERE) was the lowest it has ever been in the US, but did show a sharp uptick at the end of 2020 despite the Governments best efforts. This will probably be resolved if Biden’s foreclosure measures get through the US political system, but lets see.

However, The “Mortgage Credit Availability Index” shows a reduction in lending risk since the GFC 2008: –

• URBAN.ORG HOUSING CREDIT AVAILABILITY INDEX

• MBA.ORG HOUSING CREDIT AVAILABILITY INDEX

Chinese Housing/Property Mortgage Debt

China’s residential housing market is in a huge bubble ($9.7 Trillion debt pile). China is now attempting to restrict the market. PBOC is warning about the housing and consumer debt which is now at 62% of GDP.

Parallels are being drawn with Japans property crash in the 90’s . China is said to have an official ‘hidden’ debt pile of $2.3 Trillion. Is there a culture of hiding losses/failure same as 90’s Japan? Ratings agency S&P say this debt estimate is conservative with the true sum being 2 or even 3 times as large. We could be talking in the order of $6TILLION in debt here!

The Deputy Gov of PBOC Liu GIuping on March 16 2021 stated “We need to actively and effectively curb the spread of financial risk contagion, and resolutely maintain the bottom line of avoiding systemic financial risks”

The total market value of China’s real estate is $65 trillion. In 2019, China’s GDP was $14 Trillion. This is far more inflated than the US or European housing markets. They are trying to deflate the market now. Will they succeed? Unemployment, also hidden from Government figures, could trigger debt defaults on mortgage.

A Stock Market Crash Survival Guide

The asset allocation below tend to double up as inflation hedges: -

* Gold/Silver, possibly commodities/commodity equities (In the 70's when the big growth stock's the day were decimated by rising inflation, the stocks that benefitted from inflation such as the miners did well)

* Defensive multi-asset funds such as RICA

* Bonds (for stability and capital protection (inverse correlation to stocks))

* REITs (a proven inflation hedge)

* Utilities and consumer staples are good defensive sectors for recessionary environments

Two assets that stand out as major beneficiaries in a severe downturn:-

Gold

Gold is the standard ‘go to’ asset in many portfolios as insurance against fiat monetary debasement via central bank money printing and financial crises as outlined above. 

Hedging with Gold?

Gold is a metal that has been in use for centuries. All historical books mention the importance of gold. Today, gold has no major industrial use. Its only use is in the investment world where governments hold it for investment purposes

Traders use gold as a safe haven because they believe that if there is an Armageddon, its value will climb. In fact, the price of gold tends to move up as the dollar and the markets fall.

For instance, in August 2020, prices of the yellow metal reached an all-time high of about $2074.The upward momentum was fueled by the rising coronavirus cases. Investors were shifting their resources to gold to insure their wealth against the economic crisis. BUT... For instance, as the coronavirus pandemic took shape in March 2020, gold prices dropped to around $1450. Investors who had shifted their resources to the precious metal during this phase incurred hefty losses.

Bitcoin/Crypto

Yes, Bitcoin has been highly volatile, but so far, so good…

Since 2010 there has never been a four-year holding period for Bitcoin when it wasn’t the best-performing asset in the world (among major asset classes). 

Mega-Crash Warning Signs, Scenario's and High Risk Investment Strategies to Profit

At some point the bubble will burst as all bubbles eventually do. The first indication will be a rise in delinquencies and defaults in the Junk bonds space and in “at risk” sovereign nations such as Greece and Spain.

Once the bond bubble bursts, the fallout will be extreme. By the time it’s all over, we could see:

1) Numerous emerging market countries to default and most emerging market stocks to 

lose 50% of their value.

2) Japan to have defaulted and very likely enter hyperinflation.

3) US stocks to lose at least 50% of their value and possibly fall as far as 400 on the S&P 500.

4) Gold to break above $2,000 and likely go to $5,000 (only after Central Banks unveil the “nuclear” round of QE in response to the crisis).

5) Numerous “bail-ins” in which deposits are frozen and used to prop up insolvent banks.

6) The Too Big to Fail banks to ultimately go bankrupt and very likely be broken up.

High risk strategies to profit in this mega-crash scenario include: -

*  Shorting futures

*  Buying UltraShort ETFs

Of these two, UltraShort ETFs are the most accessible to ordinary investors. If you’re unfamiliar with UltraShort ETFs, these are investments that return two times the inverse performance of a particular ETF. Consider the UltraShort Financials ETF (SKF) as an example

SKF returns two times the inverse of the Financials ETF (IYF). So if IYF falls 5%, SKF rises 10%. If IYF falls 10%, SKF rises 20%. And so on. There are quite a few UltraShort ETFs you can use to profit from a collapse in different market indexes or in individual sectors. Below is a list of the most liquid, popular UltraShort ETFs.

1) The UltraShort S&P 500 ETF (SDS)

2) The UltraShort Dow Jones Industrial Average (DXD)

3) The UltraShort Russell 2000 ETF (TWM)

4) The UltraShort Financials ETF (SKF)

5) The UltraShort Real Estate ETF (SRS)

6) The UltraShort Materials ETF (SMN)

7) The UltraShort Emerging markets ETF (EEV)

8) The UltraShort China ETF (FXP)

9) The UltraShort Brazil ETF (BZQ)

As I stated before, these investments are not without their risk. The reason is that they are in fact based on derivatives owned by the large banks. Put another way, when you buy the UltraShort Financials ETF (SKF) you are not actually shorting all of the financial companies’ stocks located in the Financials ETF (IYF). 

Instead, you own the rights to derivatives that are meant to produce the intended return the UltraShort ETF promises. Because of this, should the bank or financial entity that issues the UltraShort ETF go bankrupt, it’s possible you could lose your position entirely.

This would not happen instantly. All crises take time to unfold. The Tech Crash, for instance, took two years to complete.

So when the next crisis hits, there will a window of time in which UltraShort ETFs will offer you the chance to see enormous returns. However, at some point, if the crisis gets bad enough, it will be best to get out of these investments altogether.

I cannot tell you when this would be as it will all be contingent on how Central Banks react to the next round of the Crisis as well as your personal risk appetite.

All I can say is that when the markets take a nosedive, UltraShort ETFs will offer the potential for extraordinary gains. But once the Crisis becomes truly systemic (meaning banks are failing) 

UltraShort ETFs will no longer be safe to invest in.