Is there another meltdown coming?

The demise of Lehman Brothers contributed to creating a liquidity crisis in banking
Claire McCombe

THE next financial crisis has begun and will be worse than 2008, economists warned in a piece for Sky News earlier this month.

The 10th anniversary of the collapse of Lehman Brothers seems to have exhumed many of the world's most committed doom-mongers from their ever shallow graves.

Too much debt remains their battle cry, and the end of quantitative easing their instrument of the financial/economic apocalypse. Of course, these stopped clocks could be right this time.

Unfortunately for investors, indulging in perennial pessimism tends to come with significant opportunity cost. Those who fell for the last major rash of recession predictions at the beginning of 2016 (when the economy was giving perhaps far greater cause for alarm than it is today) have missed out on substantial returns in global stocks.

In this context, a good question to ask yourself when reading such commentary is whether the author has actually put their money where their mouth is?

What is their track record, if indeed they have one? And where are the potential problems vs. the last cycle?

One of the major problems with investing and indeed forecasting is that it is not just different this time, it is subtly different every time. This dampens the ability of history to provide us with perfect context, even if it can provide useful relief.

In the last economic cycle, it was US households and global banks that were the main areas of excessive leverage. This cycle looks entirely different. The debt to income ratio in US households is now at a 40 year low, compared to a 40 year high in 2006.

Meanwhile banks, thanks to a quantitatively and qualitatively different regulatory backdrop, are barely recognisable from their pre-crisis guise. Balance sheets are better insulated, funding is more stable, and oversight is more rigorous and transparent thanks to regular draconian stress tests. That is not to say that there are not banks out there with problems or vulnerabilities.

However, what we have seen in this cycle is a sizeable increase in non-financial corporate leverage. Companies have used persistently low interest rates to increase balance sheet leverage both in emerging and developed worlds.

Within this, quality has declined too. The lowest rated rung, the BBB-rated segment, of the investment grade sector, is now proportionally as large as it has ever been. Charts plotting the ratio of US non-financial corporate debt to GDP look particularly alarming to the uninitiated.

However, we should probably question how appropriate a denominator US GDP is when talking about the US corporate sector, remembering that these companies are generally competing for a slice of the global pie. The debt figure looks less alarming when quoted as a percentage of corporate profits.

When set against corporate assets, we see that leverage has been on a down trend for much of this cycle, as asset values have grown faster than debt accumulation.

So there is always a multitude of concerns for investors to ponder. For a start, the details of the future will remain profoundly (and reassuringly) unknowable, however hard we try and mine the past.

Meanwhile, the world economy is always contorting and stretching in ways that confound, confuse and provoke those watching. Predicting the precise moment when these contortions come home to roost for the economy and indeed capital markets is far from easy.

:: Claire McCombe is a private banker at Barclays Wealth & Investments NI.

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