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Are You Ready For The Next Big Crisis?

Something strange is happening in the world right now. Have you noticed?

Of course, it might be premature to call the end of the Great Financial Crisis. But there are indications – albeit it fleeting ones – that tiny green shoots of recovery are starting to appear.

As a cautious person by nature, I will be the first to admit that it is always dangerous to get too optimistic about these little green sprouts. They could just turn out to be advanced mould.

But the indicators, admittedly few and far between, are there if we look closely. If we blink, we might miss them, though.

And here in Singapore, we might not even notice them at all.

Doom and gloom

What with two-thirds of Singapore businesses expecting the tough conditions of 2016 to continue in 2017. We can be forgiven to think that things are looking downright terrible.

But the US economy is starting to improve. Our will too, eventually.

Latest data appears to show that the world’s largest economy has shifted into a higher gear. It expanded at an annual rate of 2.9% in the third quarter, which is the best growth rate in two years.

Unemployment in the US is also holding steady and consumers are feeling a little less anxious. American households are starting to open their wallets to provide the impetus that the economy badly needs.

Hold the champagne

But whilst we should be celebrating the revival of the US economy, there are dangers afoot, when the American economy starts to thaw from its eight-year frozen state.

A glimpse of what could happen was provided by the way that bond prices behaved, when the UK economy recently smashed growth expectations. Bond prices tumbled, with UK Gilts leading the sell-off.

Although better-than-expected growth is always good news for an economy, it is, nevertheless, bad news for bonds. It could mean that investors could be more prepared to move into riskier assets.

That could mean falling bond price and rising interest rates.

The sell-off of good quality government bonds might be limited, though. After all, central banks always appear ready to provide a back-stop. But the same might not be true of all corporate bonds.

Nice job

When government bond yields were driven to abysmally low levels, investors started to look around for better returns elsewhere. Corporate bonds, it seems, did the job nicely.

But the surge in corporate debt is a stark reminder of just how Quantitative Easing has distorted markets.

Of course, corporate bonds can be a good source of income in normal markets. But things are far from normal, right now.

As investors start to think more positively about shares, and more negatively about bonds, they could consider ditching the latter in favour of the former. That is rational.

Troubles ahead

But here’s the thing that is really troubling.

In a normal bond market, liquidity is never an issue. Sellers can generally find willing buyers for their fixed-interest instruments.

But when there is a flood of bonds being sold, there might be little or no liquidity. Where are the buyers when only the cries of sellers can be heard?

Similarly, can companies that depend on debt be able to raise much-needed finance, when they are forced to compete with bond holders heading for the exits?

Push comes to shove

So, on top of liquidity risk, the market has to contend with credit risk too.

That’s a pretty ugly state of affairs for a market that is reckoned to be worth around US$100 trillion dollars, globally.

The key question is who will step in when push comes to shove? Will central banks still have the resolve to bail out indebted corporations, in the same way that they saved the banks in their time of need?

That is not a question that can be easily answered.

The other question is where should investors be putting their money now? That, fortunately, is a much easier question to answer.

Good shares

The principles of sensible investing have not changed. If they change, then they can’t be principles.

So, as investors, we should be looking for companies that can generate a decent level of profit on shareholder funds. They should not be heavily indebted. They should be able to raise prices, when they need to. They should generate cash etc…

These are the wonderful companies that can stand the test of time.

These are also the kind of companies that we at the Motley Fool look for constantly. We call it the Stock Advisor Way. You can find out more about the Stock Advisor way here.

A version of this article first appeared in Take Stock Singapore. Click here now  for your FREE subscription to Take Stock – Singapore, The Motley Fool’s free investing newsletter.

Written by David Kuo, Take Stock - Singapore tells you exactly what's happening in today's markets, and shows how you can GROW your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.