The conditions are ripe for a Global Financial Crisis 2.0
By: Constantin Gurdgiev, PhD
Since the onset of the Global Financial Crisis (GFC) ten years ago, academic and regulatory/supervisory research has highlighted the changing patterns in historical evidence relating to large scale financial crises. The two key changes identified in the growing body of empirical evidence points to two trends: firstly, the financial crises are now happening with more frequent regularity; and secondly, each consecutive crisis has been marked by greater degree of real economic disruption than the preceding one.
Data from historical crises post-Bretton Woods also shows that financial crises are commonly preceded by the build-up in leverage and imbalances in asset markets valuations, or, using more common language, by asset bubbles, linked to less liquid asset classes with more concentrated risk exposures.
In this sense, all evidence to-date points to a substantial increase of the next financial crisis in the global markets emerging since 2015-2016. Firstly, since the troughs of the GFC 2008 and the subsequent Great Recession, U.S. equity markets have rallied some 210% (if measured by the S&P 500 index), while other developed markets (excluding the U.S.) are up 70%, as reflected in MSCI EAFE index. U.S. Aggregate Bond Index data from Barclays shows corporate bond valuations up 45%, with Bloomberg Barclays U.S. High Yield index showing junk bonds’ yields down 690 basis points (bps). These valuations across the major asset classes are underpinned by the unprecedented expansion of the Central Banks’ balance sheets, by the increasingly complex and tightly coupled connections between the corporate credit markets and equity markets, plus the rising risk of market concentration in equities.
The three factors
In the decade since the depths of the GFC in September 2008, the combined balance sheets of the U.S. Fed, the ECB, the Bank of Japan and the People’s Bank of China rose from USD 7.7 trillion to USD 19.8 trillion, an increase of 156%. Much of this liquidity went to fund sovereign debt purchases. But, all of these funds supported to the downside the cost of corporate debt. As a result, U.S. corporate debt shot up from the pre-GFC peak of USD 6.5 trillion to USD 9 trillion today. Moody’s seasoned Aaa Corporate debt yields have fallen from around 580 bps average for 2002-2007 to below 390 bps average over 2016-present. Speculative grade corporate debt now accounts for well above 60% of all new debt issuance over the last 5 years. Covenant-light share of outstanding U.S. leveraged loans shot up from roughly 67% in mid-2015 to over 77% in mid-2018, according to the S&P Global Market Intelligence data. The Bank for International Settlements index of ‘zombie’ firms - tracking mature companies with EBITDA below debt-servicing costs, shows a five-fold increase in latent corporate insolvencies since 1985. Much of this increase is accounted for by the smaller firms, with some concentration in high leverage sectors, such as energy, oil and gas, and others. However, the index does not track the unicorn start ups in the tech sector, excluding a large set of new asset classes (private equity, VC, and start up equity and debt markets) that have material presence in today’s markets.
In simple terms, the post-GFC quantitative easing programs deployed by the major Central Banks have delivered a massive credit and equity boom, in line with the dynamics of the pre-GFC risk mispricing, and consistent with the traditional pre-crisis risk build-up dynamics.
The above also hints at the tighter coupling of debt and equity market risks. Ultra cheap credit available to corporate borrowers has fuelled more than a simple rise in equity returns performance that can be attributed to lower credit costs. Instead, the credit boom fuelled a massive shares buy-backs binge by the major corporations. Dividends and net buybacks have soared from the average of 0.023% of U.S. GDP over 1985-2005 period to nearly 0.05% in 2010-2018. Fuelled by the Trump Administration’s 207 tax cuts, the first 6 months of 2018, payouts as a percentage of GDP rose to 0.058%, more than two and half times higher than in the decades preceding the GFC. Per a research note published by the U.S. Fed last month, “In dollar terms, buybacks increased from USD 23 billion in 2017:Q4 to USD 55 billion in 2018:Q1." Worse: "among the top 15 cash holders, the largest holders accounted for the bulk of the share repurchases: In 2018:Q1, the top 5 cash holders accounted for 66%, and the top holder alone accounted for 41%." And, based on data from S&P, buybacks are accelerating in H1 2018, with Q2 2018 marking an absolute historical high at USD 1.0803 trillion (annualized rate) of share buybacks.
The U.S. and other advanced economies' equity markets are becoming increasingly concentrated. Total Gross Issuance of Stocks, net of S&P500 share buybacks has fallen from the 1999-2004 average of near-zero to a negative USD 600 billion in mid-2018, based on the data compiled by Yardeni Research. Looking at the changes in the market cap of the 35 largest publicly listed companies since 2012, Facebook accounts for 56% of stock market gains, followed by Alibaba (29%) and Square (3%). High risk M&A activities—also driven by low credit costs—is further exacerbating the problem: per FactSet, "the first half of 2018 has reported the second-highest level of deals valued over USD 1 billion with 200 deals; the highest level was attained in the first half of 2007 with 210 deals. It is also worth noting that [since] 2013, ...there have been over 100 billion-dollar deals in each half-year. Even in the run-up to the financial crisis the streak was only three years (2005 to 2007). And to help complete the pattern, the dot-com boom had a similar three-year streak of 100 billion-dollar deals in each half-year from 1998 to 2000."
In simple terms, lax credit conditions, cheap cost of debt and reckless chasing of yields by the corporates, fuelled by the unprecedented money printing by the Central Banks over the period post-GFC has now inflated asset market bubbles well beyond the risk levels seen in the run-up to the last crisis. Today, virtually all financial markets are more reckless at mispricing financial and strategic risks and uncertainties, more concentrated and complex in terms of contagion pathways and exhibit more ambiguity and complacency in investors' perceptions of the core risk dynamics than at any time in living memory. Unlike the dot-com bubble and just as at the time of the onset of the GFC, we are in an explosive VUCA environment of heightened volatility, uncertainty, complexity and ambiguity; the environment that has served as the basis for every single one of the past major financial crises.
While the large scale, systemic blowout in the financial markets is no longer a prospect worth doubting, the timing of the next market collapse is much harder to predict. Thanks to the very cautious tightening of monetary policies, to-date, credit carry costs remain benign even for the financially fragile companies. And the recent experience with quantitative easing suggests that the central banks have acquired a virtually limitless willingness to continue underwriting fiscal and corporate recklessness into the future.
Cyclically, the U.S. economy (as well as that of the EU) is overdue a recession. Consensus amongst macroeconomic analysts suggests the recession around late-2020. It is highly likely that, given current forward guidance, the recession will arrive somewhat earlier, some time around the end of 2019-start of 2020, triggering a large downward correction in financial markets. Unless, of course, a different shock, arising from the ongoing problems in the financial and real economies across the emerging markets and China, leads us into a global downturn ahead of the U.S. and European one. Timing is a precarious game of guesses and ambiguity-rich analytical forecasts. That said, the fundamentals are now ripe for a Global Financial Crisis 2.0. History tells us, it is likely to be more painful than the previous one.
Dr. Constantin Gurdgiev is Professor of Finance at Middlebury Institute of International Studies at Monterey and continues as adjunct assistant professor of finance at Trinity College, Dublin. He is a co-founder and Chairman of the Irish Mortgage Holders Organisation, and a co-founder and director of iCare (https://www.icarehousing.ie/), and serves as a partner and a board member with a number of international financial services providers. Dr. Gurdgiev was one of FocusEconomics's Top Economic and Finance bloggers of 2017 & 2018 as well as a Top Economics Influencer. Visit his blog True Economics as well as his website MacroView for more from Constantin. You can also follow him on Twitter here.
5-year economic forecasts for 127 countries & 30 commodities.
Date: October 23, 2018
TagsVenezuela Sub-Saharan Africa Argentina Spain Greece Banking Sector OPEC MENA Consensus Forecast South Africa Brexit Commodities USA Russia Gold Mexico Bitcoin Portugal Nordic Economies IMF Italy Germany Base Metals Commodities India United Kingdom Latin America Infographic France Investment Turkey Housing Market Canada Euro Area Brazil Ukraine United States Vietnam Exchange Rate Trade Agricultural Commodities Iran oil prices Oil Inflation Economic Growth (GDP) Africa Japan China Eurozone Australia precious metals UK Emerging Markets Precious Metals Commodities Tunisia G7 Unemployment rate European Union Eastern Europe Healthcare Major Economies Company News TPP Forex Asia Cryptocurrency Colombia Energy Commodities
Analysts see base metal prices rising 7.6% year-on-year in Q4 2019 (last month: +6.2% yoy). Read more: https://t.co/KlgaC9IbxP
11 hours ago
The Guatemalan economy is projected to expand 3.1% in 2019 and 3.0% in 2020. Read more: https://t.co/JdM2ep1Com
13 hours ago
Argentina's inflation is expected to be 29.0% at the end of 2019, which is up 1.2 percentage points from last month… https://t.co/6Z6z1lcdgY
15 hours ago
GDP in Brazil is seen growing 2.4% in 2019, which is up 0.1 percentage points from last month's forecast, and expan… https://t.co/hHt506suN2
15 hours ago
Agricultural prices are expected to increase 5.6% year-on-year in Q4 2019 on solid food demand thanks to the world'… https://t.co/rBF0qJ4clw
17 hours ago
- Canada in 2019: Interview with a Top Economic Forecaster
- Pound Sterling 2019 Exchange Rate: Projections from Leading Analysts
- Expectations for Latin America’s Economy in 2019
- Ethiopia and Rwanda: From Destruction to Development
- Key commodities trends to look out for in 2019
- What drove Gulf neighbors to bail out Bahrain?
- The Four Financial Bubbles and Their Impact on the U.S. Economy
- The Poorest Countries in the World
- Italy: The sick man of Europe
- What does Bolsonaro's presidential win mean for Brazil's economic outlook?
- The World's Top 10 Largest Economies
- In Latin America, taxpayers are tapped to shoulder the burden of a bank bailout
- How and when will the next financial crisis happen? - 26 experts weigh in
- China and Africa: A partnership under the spotlight
- The conditions are ripe for a Global Financial Crisis 2.0
- Uncertainty, instability and fear haunt a generation of Argentinians
- 5 things: What to expect for Mexico's economy in 2019
- 5 things: Brazil's economic downturn and what to expect going forward
- Emerging Market Currency Crisis: Everything you need to know
- Which ASEAN countries are most exposed in the event of a U.S.-China trade war?
- 75 Top Economics Influencers to Follow
- Emerging Markets Economic Outlook 2018 and 2019
- The Faces Behind Latin America’s Key Institutions
- 2019 Economic Outlook for the Top Oil Producing Countries
- Is your cup of coffee about to get more expensive going in to 2019?
- The Economic Implications of an Aging Global Population
- Can the Wisdom of the Crowds predict the results of the 2018 World Cup?
- Railway Mania: The Largest Speculative Bubble You’ve Never Heard Of
- From Riches to Rags: Have Cryptocurrencies Crashed for Good?
- Investment looks to Latin America, but forecasts are not encouraging
- Turkey: Erdogan has cemented his grip on power - now what about the economy?
- How can Latin America’s business environment benefit from technological change?
- Mexico: A look at the past, present and future as elections yield AMLO victory
- Italy’s New Populist Government and the Eurozone: Prelude to a Crisis?
- Latin America moves toward increased integration as U.S. protectionism grows
- How can Latin America increase productivity without affecting the quality of employment?
- How will Saudi Arabia's economy benefit from lifting the women's driving ban?
- Which countries are the most prepared for the upcoming digital revolution?
- India Under Pressure from the U.S. on Trade Policy
- The Story of Steel
- Latin America is the World Leader in eCommerce Growth Despite Serious Challenges
- What the TPP means for trade in Latin America
- Elections in Russia: Analysis and Implications
- Nearly a Third of Latin Americans Have No Right to a Pension
- A Look at Healthcare Models Around the World
- Newly-elected Chilean President Sebastian Piñera faces a myriad of challenges - economic and otherwise
- The Economic Effects of Trade Protectionism
- Regional Disparity: The Dark Side of Inequality in Latin America
- Coal: The story of the world's most abundant fossil fuel
- Venezuela's Electoral Conundrum
- Gold: The Most Precious of Metals (Part 3)
- Trump's 1st Year: 95 Analysts Surveyed on U.S. Economy
- The Latest on China and What's in Store for 2018
- An in-depth look at the Eurozone’s booming economy and the challenges that lurk in the shadows
- Increasing poverty in Latin America takes a breather thanks to improving economic dynamics
- What will be the most miserable economies in 2018?
- Is Spain doing enough to address its high youth unemployment rate?
- Has Latin America gone far enough in reducing barriers to international trade?
- Commodities Outlook: Oil, Natural Gas, Coal, Lead & Tin
- 21 experts tell us what the future looks like for cryptocurrencies and blockchain
- Turkish lira plummets to all-time low on Erdogan’s monetary feud and tense U.S.-Turkey relations
- Copper: The first metal mastered by man
- Nigerian Economy Still Treading Water Thanks to Oil Sector
- The Mercosur-EU Free Trade Agreement: Obstacles & Opportunities
- Elections in Chile: What the results could mean for the economy
- QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate
- Holland’s fragile one-seat majority government targets economic growth at the expense of fiscal sustainability
- South Africa: Economy at a tipping point?
- Latin American Commodities: What’s behind the increase in demand and prices?
- Is the UK really "shackled to a corpse"?
- Spain-Catalonia: 7 economic experts weigh in on how the situation will affect the outlook
- How well is Spain's labor market doing since the crisis?
- Which countries will have the highest and lowest inflation in 2017?
- How vulnerable is Latin America to economic crises today?
- Iron ore facts and common questions answered
- The bulging economic costs of obesity
- How much investment is needed to salvage Latin America’s crumbling infrastructure?
- A Look at the Potential Impact of Brexit on the Dutch Economy
- Emerging Markets Are Kicking Into Higher Gear In 2017
- Why is foreign direct investment in Latin America falling again?
- Are Central Banks Nationalising the Economy?
- Bounty or burden? The impact of refugees on European economies is far from clear
- What’s the future of U.S.-Latin America trade relations?
- Taxes or cutbacks? Latin America's challenge of sustaining spending without causing debt to skyrocket
- Are uranium prices making a comeback?
- Taxing the Economy: Achieving a Delicate Balance
- How will Latin America’s upcoming lengthy election cycle affect the reform agenda and credit ratings?
- How will emerging market economies perform in 2017?
- Chilean Economy in Focus: Interview with Senior Economist of the Chamber of Commerce of Santiago
- CEOs Rank Top Economies for Growth Opportunities
- The Mobile Ecosystem & Latin America's Economy
- Prospects and Challenges for the Global Economy: Interview with Tim Cooper from BMI Research
- How will the Fed reduce its balance sheet & and how will the ECB end QE? - 19 economic experts weigh in
- Thoughts on "unwinding" QE from Frances Coppola
- The Fed and ECB at a crossroads: Unwinding QE
- Spain: The economy that continues to silence the critics
- Latin America: The Most Unequal Region in the World
- The History of OPEC: Has it been a Success?
- FocusEconomics Announces 2017 Analyst Forecast Awards Winners
- Latin America’s rising unemployment bucks nearly decade long trend
- Escape from the Central Bank Trap by Daniel Lacalle
- China's economic rebalancing act: What to look out for in 2017
- Driving Growth in Latin America: Challenges & Priorities
- Is the Global Economy Rebalancing?
- Commodity exporters face challenging times
- Recent Global Events Facilitate Mercosur-Pacific Alliance
- 23 economic experts weigh in: Why is productivity growth so low?
- Mexico's outlook as Trump nears 100-day mark
- Interview with Oxford Economics Senior Economist on implications of the possible outcomes of the French Presidential Election
- The anxiety of the small saver in a world of negative interest rates
- Brexit negotiations. Between Uncertainty and Urgency
- An Economic History of the EU from El Blog Salmón
- Baby Boomin': Implications of high population growth in Latin America
- Survey of International Economists Predicts a Le Pen Defeat in French Elections, Says Macron has Best Economic Plan
- Spain in a global context: developed economy with some challenges
- How much is crime costing Latin America?
- Predictions & Estimates from Economist Daniel Lacalle
- What economy will the new Dutch government inherit?
- “The data is not a true reflection of reality in India” Interview with Société Générale India Economist
- What are the prospects for Emerging Economies in 2017?
- What to expect in Asia for 2017
- Top Economics & Finance Blogs of 2017
- Latam to Resume Moderate Growth in 2017 but Important Risks Plague Outlook
- 4 Key European Elections That Will Impact the Economy in 2017
- How are security concerns and political chaos affecting Turkey’s economy?
- Global growth to edge up in 2017
- Set to breach targets again? Debt and deficit outlooks for Southern European Eurozone countries in 2016 & 2017
- What does Donald Trump mean for the U.S. economy?
- How will emerging markets perform in 2017?
- The economic impact of a break in U.S.-Philippines ties
- Trump election: Base metals surge due to infrastructure plan
- 5 updates on the Venezuelan economic crisis
- Canada: When your neighbor’s house is on fire…
- Short-term pain before long-term gain? A look at French labor reform and economic growth
- Asia: Unremarkable growth & unfulfilled promises?
- How India's latest monsoon is affecting the economy
- Innovation in Latin America: Potential Goes Untapped Due to Weak Economic Conditions
- Russian economy update in wake of OPEC deal announcement
- The Wisdom of the Crowds and the Consensus Forecast
- Can the peso predict the U.S. election results?
- There's no end in sight to the Venezuela crisis
- A Look at the European Union Political Calendar
- Survey of international economists shows uncertainty surrounding elections damaging U.S. growth prospects
- FocusEconomics partners with leading online statistics provider Statista
- China: Recent postive economic data may be papering over the cracks
- Sub-Saharan Africa's 2016 & 2017 growth rates
- The Italian Dilemma: Weak banks pose risk to already faltering domestic demand
- How much money do migrants from Latin America send home?
- The U.S.' (Not So) Mysterious Case of the Missing Men
- What to expect from the G20 economies by 2020
- The Pain in Spain: Robust GDP growth cannot mask the persistent structural deficit