Where is the next financial crisis going to happen?

Sree Iyer

The Dow is scaling new heights – NASDAQ and S & P 500 are also trending upwards and the bull market is now 6 years old in the US. How long is this bull run going to continue and what can trigger a downward trend? More importantly, with so many countries inter-connected, could a crisis in one country affect the world as a whole?

Forbes magazine published this article 6 months ago, on the 10 possible reasons that could cause another systemic crisis. Several other articles have predicted that Junk Bonds could be the next trigger for a financial crisis. We at PGurus think that any one of the following can cause the next financial debacle:

• Greece defaults on this debt payments and European Union (EU) refuses to bail it out
• US Stock market is around $70 trillion and depending on who you talk to, its derivatives market is between $700 trillion to $7000 trillion! Even a small downturn in this market could lead to disastrous consequences
• Europe’s Quantitative Easing program might end up exposing the underlying risk of Euro, causing a run on its value

Greece just announced that they do not have enough money to pay the next installment to the IMF. This could set off another round of negotiations and re-structuring, with the usual posturing by Germany of the importance of austerity measures and after a few days of roller coaster behavior, stocks will resume their uptick. But one wonders how long EU will wait before pulling the rug from under Greece.

The Millenium report estimates the derivatives market to be of the order of $1.5 Quadrillion. That is $1, 500, 000, 000, 000, 000, 000! While this may seem to be absurdly large, it underlines the fact that no one really knows the size of this market. Warren Buffett calls the Derivatives market, “financial weapons of mass destruction”.  Many lawmakers and even financial experts cannot explain exactly what these derivatives do and blissfully legislate/ trade them. In fact these derivatives were one of the prime reasons behind the 2008 crisis and the Dodd-Frank bill, which was supposed to address this has been watered down so much (thanks to lobbying) that it barely touches them. So much for learning from past mistakes!

Europe started its QE program on March 9, 2015 at a monthly rate of €60 billion till end of September 2016 and continue further if necessary. All other countries such as the US, UK and Japan did their own QE with relative success but in the case of EU, there are several countries involved and this can be a detriment. Many analysts believe that the Euro will start losing its value vis-a-vis the dollar to $0.55 (today it stands at $1.11), by the end of 2016, almost a 50% drop! This runs counter-intuitive to what happens when Quantitative Easing takes place so let us wait and watch.

So what is the investor to do? Diversify, put money under the mattress or buy gold?

Diversify

Not all countries are playing the Derivatives market and it might be useful to look at the potential of some of the emerging countries (such as India) which have the potential to grow at a brisk pace. One argument put forth is that India keeps changing the rules of investment and therefore is a risky place to invest but thanks to the pragmatism exhibited by the current regime, this may be a thing of the past.

Stay liquid

Taking all the money out of the market may not be so easy as there maybe penalties that you may incur, especially from Individual Retirement Accounts/ 401(k) plans etc. Plus timing the market for such events is never a perfect process, especially if you get out of stocks only to see the market continue to go up.

Buy Gold

Buffett does not think buying Gold for the long term is a good idea but today, with the value hovering around $1200 to a troy ounce, Gold is a good interim investment , for a period of 2-3 years. It also serves as a realistic barometer of the nervousness in the market… When the big players are not sure, they tend to buy gold and if you see the price start rising, you may want to put some of your investments in Gold.