The next financial crisis is coming. I’m absolutely certain about that. I just don’t know when.
Should you be worried about the next financial crisis? No, of course not! Unless you are not prepared for a financial crisis that is.
I consider myself lucky to be on a journey towards financial independence. Already now, I have net worth that can allow me to sustain my current lifestyle for a couple of years despite what happens during the crisis. Most people do not have that opportunity.
I have learned to love financial crises. I see a financial crisis as an opportunity to make financially sound decisions in a calm manner while most people panic. Warren Buffet is often cited for this opportunity:
“And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful”
– Berkshire Hathaway 2004 Annual Shareholder Letter
A financial crisis is a perfect time to buy stocks because many stocks are being sold at a bargain.
At the same time, I obviously feel very bad for people that are not prepared for the next financial crisis. For these people, a financial crisis will have severe consequences.
When will the next financial crisis come? I have no idea, but there will be several more crises in our lifetime – that is for sure!
Looking at the past few years, however, it is fair to say that the markets have been looking fairly bright. Following this, I believe that we are now starting to see some concerning trends in the global economy.
When will the next financial crisis hit?
Nobody knows when we’ll see a financial crisis of nuclear proportions again. However, as a general rule of thumb, the next financial crisis will arise when a lot of people lose confidence and become nervous at the same time.
I have collected a few graphs from different parts of the world wide web that I find disturbing and could point towards a financial crisis in the near future (or at least periods of stagnation). Some of these could lead to a lot of people losing confidence at the same time, which would make the markets crash.
We have had a great run in the past decade and people are starting to forget that things could be bad and markets could crash. This is when things become dangerous.
Governments and central banks across the globe have held interest rates historically low to create economic growth, and they have actually succeeded in creating a global economic upswing, but as soon as interest rates start rising (and they will have to at some point), we might face a different reality.
Another thing I am worried about is debt. Let’s have a look at the US debt balance:
Source: Federal Reserve Bank of New York
The US debt balance has been increasing rapidly in recent years following a decline after the 2008 financial crisis. We are now above pre-crisis levels, and if you remember how debt was packaged in all sorts of creative ways pre-crisis with extremely bad deals for the consumers, you will be as nervous as I am about this development.
You think the US looks dangerous? The US might actually have learned their lesson, so there’s actually countries that look more concerning when we look at private debt to GDP ratios:
Source: Steve Keen
Yes, the US private debt to GDP is on a slightly upward trend again, but take a look at some of the countries that did not learn the lesson from the last crisis. Countries like China, Korea, Australia and Belgium have had increasing credit bubbles ever since the financial crisis. China is definitely the fastest growing of them – and also has a significant size. What would happen with the global economy if China had a similar meltdown compared to what happened in the US in 2008 when the credit bubble burst?
Let’s have a look at the stock markets.
The price/EBITDA ratio is showing that we have never had a higher price per EBITDA in the history of mankind:
Source: David Stockman
This means that the prices of the company stocks in the S&P 500 have never been higher relative to how much the companies have in earnings (before interest, taxes, depreciation and amortization). This could indicate that we might be heading towards a market correction (at best) or a financial crisis (at worst) – especially when interest rates start increasing again.
People believing that the current market is a fair representation of the companies’ real value would argue that it does not factor in inflation, future earnings growth potential, new technologies, Trump’s policies etc. etc.
Do I believe them? To some degree, yes, but no, I really don’t. I don’t see how the market can increase 240% since March 2009 with the economy still creeping along at low growth rates. The S&P has consistently increased nearly every single month in the past seven years. I believe that this kind of optimism is most likely closer to a correction than to the early stage of a market increase… but I might be very wrong!
Let’s take a look the US savings rate:
Source: David Stockman
If a crisis were to hit, we might be in for a rough time – or at least the Americans might be. With less and less money in the bank to actually power through a recession, we might feel the consequences of a market correction, recession, stagnation/crisis a lot harder.
And as if low savings rates weren’t bad enough, we might be in a global real estate bubble getting closer to pre-2008 levels:
… with some countries having very rapid increases in house prices going above pre-2008 levels:
Source: The Telegraph
Ok, ok. Let’s relax. I’m painting a doomsday picture, I know. I’m taking a lot of different graphs and try to draw simple conclusions from very complex interdependencies (or lack hereof). I might be creating fear without reason.
I just find these graphs super interesting. I know that there’s many underlying things that could explain the trends on the graphs. I also know that the trends on the graphs above do not necessarily lead to a financial crisis.
But I still find some of these hockey stick growth patterns somewhat worrying.
I am certain that I will experience more financial crises in my lifetime, but whether it is tomorrow or in 10 years, I can’t say… and the graphs probably can’t either.
The good thing about it all? I don’t care what happens because I have my strategy set.
How to behave during the next financial crisis
If you are on a journey towards financial independence or are investing for the long run, you have less to fear. Crises will come and go. Your net worth will increase, your net worth will decrease, and hopefully, it will mostly increase.
At all times, I believe you should be focused on building up your net worth and save as much as you can every month. This makes you able to withstand large decreases on the stock market or getting laid off from work for a certain period of time.
The good thing about pursuing financial independence is that you most likely already live a relatively frugal lifestyle, so if the crisis hits, you can easily cut your spending to the bare necessities. You don’t have to pay for an expensive yacht or an over-sized house every month. This makes you able to ride out the storm.
Concerning investments, I believe you should set an investment strategy and stick to it in good and in bad times (this requires some strength!). I keep on investing when the markets are down. This is when you get the best bargains as crises are bargain fiestas! But I also invest when the markets are up. You might invest at the top and lose money, but you also invest at the bottom and gain a lot. If the markets continue growing overall in the long run, we’ll be fine.
Instead of being afraid of when the next financial crisis will happen and what will happen, we should embrace the next crisis and act wisely while we ride out the storm. The next financial crisis will be a lot more fun if you are prepared for it!
What do you think? Am I being way too pessimistic about the future? Let me know in the comments.