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3 Triggers That Could Push This Sell-Off into a Financial Crisis

Stock-Markets / Financial Markets 2018 Nov 12, 2018 - 06:33 AM GMT

By: John_Mauldin

Stock-Markets There’s very real possibility the global economy breaks down in the next six months.

Anything could trigger a crisis, and it could well be something no one now foresees. But here are my three candidates.

Corporate Credit Crisis

US companies are way more leveraged now than they were ahead of the 2008 crisis.


We saw then what happens when the commercial paper market seizes up. And that was without a Fed in tightening mode.

Now we have a central bank both raising short-term rates and slowly ending its crisis-era accommodations.

Recent comments from FOMC members say they have no intent of stopping, either. A few high-profile junk bond defaults could ignite fears quickly.

There are trillions of dollars of low-rated corporate debt that can easily slide into the junk debt category in a recession. And most public pension, insurance, and endowment programs are not legally allowed to own junk-rated debt.

I can see where it could easily cause a debt crisis along the lines of the previous subprime crisis.

Trade war

One reason the US economy seems to be booming right now is a surge in imports. Companies are rushing to build inventory ahead of the 25% tariff on Chinese goods that takes effect January 1.

Coming on top of usual holiday season stockpiling, it is jamming ports, highways, and warehouses—generating many jobs in the process.

That’s all good right now. But those truck drivers and warehouse workers will no longer be necessary once the shelves are stocked.

Working down that inventory will take months, at least. And the resulting slowdown could ease the economy into recession next year.

We might avert that outcome if the US and China reach some trade resolution, but that doesn’t appear likely.

The latest reports say the Trump administration is digging in for a long siege. Nor does China seem likely to bend.

You may have heard the tennis term, “unforced errors.” Those are mistakes of your own, not a result of your opponent’s good shots. I think the tariffs may be an unforced error in US economic policy that could cause a serious growth decline, or worse.

European Slowdown

We recently got October PMI reports from Markit.

Its eurozone manufacturing and services index dropped to the lowest point since September 2016. Export-dependent Germany looked especially weak.

Meanwhile, Italy’s new budget is wildly out of line with its revenue and growth prospects. This threatens to set off another euro crisis.

And then there’s the serious possibility of a hard Brexit in early 2019.

In short, Europe is in real danger of entering recession next year.

If that happens, the impact will spread around the globe as the continent reduces imports from the US, China, and elsewhere.

Not to mention the potential fireworks if Italy or anyone else actually defaults on debt payments to foreign lenders.

If the European Central Bank won’t buy Italian bonds, and the Italians won’t do it themselves, then Italian interest rates could soar, triggering a crisis.

This is essentially what forced the ECB into its first quantitative easing program.

In theory, the Italians were in compliance back then. That is not the case today.

I have been pointing my finger at Italy for years. It is the linchpin of the whole euro experiment on debt and solidarity.

I could go on, but you get the point. The US economy looks fine just ahead, but problems lurk over the horizon. Bad things could happen soon.

So, What Do You Do?

I have three suggestions.
  1. Build a cash reserve

I know every financial advisor says that, but disturbingly few people actually do it. Have several months of living expenses readily available in risk-free cash equivalents. Cash is also an option on buying discounted assets at lower prices in the future.

  1. Deleverage

If you carry business or personal debt, reduce it as much as you can and don’t assume you will be able to refinance. Banks can cut your credit lines in a heartbeat, and they will.

  1. Have a plan for your longer-term investments, whether they are stocks, real estate, or anything else.

Decide now what you will sell, and to whom. Because buyers may not be there when you need them. At the same time, decide what you plan to hold through any slowdown. I have assets in private companies and even a few public ones that I truly consider “for the long term.”

I sincerely hope I’m wrong. Maybe I’m jumping the gun here and 2019 will be another banner year. But I see major risks ahead, and I want you to be ready for them.

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Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

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