When working in the financial industry, you are often asked a question when the next financial crisis is coming. Some think that it is an unquestionable certainty and all investment companies should have a plan of action, waiting for the signal to be implemented. In this article, we aim to find out why some are certain that the crisis is coming, what are the early signs and how the P2P investment companies will be affected.
Crisis, what crisis?
Last year was remarkable, as it was a 10-year anniversary since the financial crisis of 2008 has happened. It was the worst recession ever since the Great Depression and as a result, one-sixth of global GDP was lost. It was natural that financial professionals wanted to sum up the good developments that have happened during the past ten years, what has changed and how we are going to avoid the same mistakes in the future.
What is striking right now is that some people actually believe that the crisis is going to happen within a year and asking how we are prepared for it. Economics theory can be debated forever, however, there is only one certainty- you can’t predict nor prevent the crisis. When someone is certain of the date of the crisis- it raises questions. Usually, a crisis is provoked by the drastic fall in asset prices. So, if someone is aware of the upcoming crisis it means that this informed person has prepared and already adjusted his/her portfolio. However, if everyone is prepared it means that the asset prices are not inflated. One of the prominent economists John Maynard Keynes has argued that the business cycles are influenced by over-optimism and future expectations, which currently is not the case.
For how long can we grow?
Of course, the fears about the future recession are not unreasonable. During the time of globalization, all economies are interconnected. The U.S., the biggest economy with an output of $21 Trillion (a quarter of global) has a tremendous effect on the rest of the world. The U.S. economic history suggests that the boom (GDP growth of around 2-3%) is always followed by a bust. Boom is almost always accompanied by low employment, growth in housing prices and asset prices and historically lasts just over three years, then the overheating phase kicks in. As of July 2019, the US economy grew for 121 consecutive months, a record since 1854, when America started to keep track of growth.
S&P500, the main American stock index had a record bull run, which was interrupted for the first time at the end of December 2018, as you can see in Figure 1 below. Such an incredible rise in the stock prices could be associated with overheating of the economy. However, it is probably due to the mixture of factors, like the favorable policies of president Trump to corporate America. So, when the index had a backdrop in December the panic went around, that this is it, the share prices are falling. However, the prophecy did not come true and the index bounced back, earning 19% year-to-date.
What can influence the next crisis:
One of the major threats is that the globalization may go in reverse. The trade war between US and China is already having its impacts. In 2018 the US has imposed tariffs of up to 25% on Chinese goods worth $250 Bn, another $325 Bn worth of Chinese goods are threatened to have additional tariffs in 2019. China is fighting back with tariffs on US goods. The trade-tension between US and China is not only dangerous to these two economies, but to the rest of the world too. The WTO chief has warned that this stand-off may lead to a major trade crisis since 1947.
The effect of the trade war was already felt this month when China has posted its Q2 2019 GDP growth figure of 6.2%. Of course, such rate of growth is impressive for a $13 Trillion economy, however, it was received pessimistically, since it is the lowest figure in almost 30 years (the usual growth figures in China were in double digits). The slower Chinese growth isn’t just bad for China, it has spillover effects on other emerging economies. Resource-rich countries like Nigeria, DR Congo, Chile, and Brazil all export commodities such as iron ore, copper, etc. to China, hence indirectly they will feel the slower growth too.
Another vulnerability to the global economy is coming from low-interest rates. As Kenneth Rogoff, Professor of Economics at Harvard University, and former chief economist of the IMF mentioned the low-interest rates give little room to Central Banks to have an emergency response in unfavorable circumstances. Prof. Rogoff, by the way, thinks the crisis is not happening very soon but is afraid that with such low-interest rates the US monetary policy will not become a safeguarding tool, in case the US economy will have an unexpected downturn.
The Fed (US Federal Reserve) has hinted that during the next Federal Open Market Committee on July 30th the policymakers are probably lowering the interest rates. Currently, the rate is at 2.5%. The possible reasons for a rate cut could be slower than expected US GDP growth in Q1.
|US Economy QoQ GDP growth|
|Source: Trading Economics|
The latest survey by the National Association of Business Economics, which interviewed 53 professional economic forecasters has found out that 60% of them expect the crisis happen by the end of 2020. Only 15% expect it to happen by the end of this year. The trade war was named as a primary threat to economic prosperity and the second reason were linked to economic variables such as consumer spending, job growth, and the housing market investment. The US economic growth is driven by the consumers, so it is understandable that forecasters get cautious, when the growth in these figures start to slow down.
How to prepare
After the financial crisis of 2008, it was very unclear, where to invest your money. Thankfully, many investors enjoyed positive returns in stocks, since the US stock market has hit records and was growing for 10 consecutive years.
However, to protect your investments from unexpected swings in the asset prices became more difficult, since the correlations between asset classes have increased after the crisis. The core principle of investing is diversification, as it helps to reduce risk. If the price of one asset in your portfolio has unexpectedly declined, the total portfolio value won’t be affected if you have invested in different uncorrelated assets. According to a Blackstone study, the correlation between prices of major asset classes has increased in 2008-2017, if comparing to 1998-2007. The study has compared most common assets such as stocks, bonds, REITs and commodities.
So, how can we diversify if this is the case? The answer is to include alternative assets to complement your well-structured portfolio. However, it is a mistake to treat all alternatives as one asset class, as they are following different cycles. So, if you are a P2P investor you should plan a budget just for this asset class. If you think that financial crisis is just around the corner, P2P loans are a great choice, as it is alternative investment, hence alternative asset class. Grupeer has already written an article explaining why 2019 is the year to be in P2P loans, you can read it here.
Previously crises happened due to housing bubbles, external shocks, such as oil prices, or industrial melt-downs. Now the picture is different, the growth is slow, but it is different, fueling the expansion of intangible assets and services. So, maybe this different economic growth can be maintained for a much longer period? In any scenario, if you invest in P2P loans you shouldn’t be afraid of the crisis. The prospect of the next financial meltdown is frightening to firms and assets which rely on the cheap money offered by banks right now. The P2P loans, on the other hand, are already living outside of the world of low-interest rates. The companies, who are borrowers in this business model agreed to high-interest rates and they are sustainable for them, so you can confidently add P2P loans to your well-diversified investment portfolio.