Financial Crisis in 2016 Is Coming, Despite Widespread Confidence

Financial CrisisEconomic Collapse in 2016? It’s Possible

For the most part, if you ask someone what was behind the 2008 financial crisis, they’ll probably say greedy, unscrupulous Wall Street banks and their overpaid vault-keepers. While the 2008 financial crisis cannot be blamed on any one single event, it’s safe to say the vast majority of issues behind the financial crisis were indeed related to the banking industry (irresponsible mortgage lending, securitization of loans, credit default swaps, off the balance sheet risk, etc.)

Have things changed much since the downfall of Lehman Brothers or the rescue of Bear Stearns? Not really.

Eight years later, you can still feel the effects of the financial crisis. The Federal Reserve’s generous trillion-dollar quantitative easing experiment may have prevented a depression but the so-called economic “recovery” remains fragile—everywhere.

2008 Financial Crisis Still Being Felt

The blame of the U.S. financial crisis can be laid at the Gucci-clad feet of Wall Street banks and their exuberance to mask risk, pass it onto others, and make money at any cost.

Other global financial institutions also made a lot of money using the same game plan. European banks borrowed money to buy into the same dodgy securities and they did quite well—at least until the global financial crisis started to catch up with them.

But then the banks did what they do best: they socialized their losses and privatized their gains. Immediately after they got their ill-deserved handouts, the banks were more than happy to pass on the financial crisis baton and responsibility to the Federal Reserve and other central banks. Or rather, central banks were happy to take the baton and take control. Trillions and trillions of dollars later, the global economy has not exactly been kick-started.

Eight years on and the effects of the 2008 financial crisis and stock market crash are still being felt. Gross domestic product (GDP) is terrible in the biggest economies, U.S. stocks are in an earnings recession, U.S. economic growth is anemic, the average American is living paycheck to paycheck, and, in the midst of all of this volatility, the Federal Reserve is deciding when to raise rates.

U.S. Financial Crisis

As one recent headline observed, “Times are hard for bankers—but they did nearly bankrupt the planet.” Before the financial crisis and stock market crash, few investments were as secure as banks. Almost a decade later, though, banking stocks are still a tough sell. (Source: “Times are hard for bankers – but they did nearly bankrupt the planet,” The Guardian, April 24, 2016.)

And the future does not look bright for banks. At least, not according to a new global survey of economists and other social scientists from across the U.S., Europe, and South Africa. The respondents said another financial crisis would hit in the next five to 10 years as a result of the unregulated growth of “shadow banking.” (Source “The Future Expansion and Proliferation of Finance,” Leeds University Business School, May 2016.)

One would think the financial crisis would have made bankers sit up and take notice. Instead, tighter regulations have made banks conduct more activities off the balance sheet, while non-bank financial businesses are taking advantage of loopholes and poor regulation.

The fact of the matter is that the financial industry has not learned from the global financial crisis. As a result, some banks are careening back onto the same path that led us to the 2008 financial crisis.

And really, why not? It’s not as if the Federal Reserve and other central banks won’t step in to save them.

U.S. Economic Crisis

It’s pretty tough not to tie the stock market in with the economy.

Since the stock market is propelled by the economy, stocks don’t do well in a depression. On the other hand, stocks tend to be bullish when the economy is strong. At least, that’s the way it’s supposed to work.

You wouldn’t know it by the state of the S&P 500 and underlying U.S. economy, though. With the S&P 500 just a percentage point away from a new all-time high, you’d be forgiven for thinking the U.S. economy is running on overdrive.

Even economic bulls like JPMorgan think the U.S. is edging toward a recession. Economists at the bank recently said the probability of a recession occurring within the next 12 months has never been higher during the “current economic recovery”—for those who are fortunate enough to feel the benefits of a recovery. (Source: “JPMorgan: The odds of a recession starting in 12 months has hit a high,” Yahoo! Finance, June 7, 2016.)

The banks said that the probability that a recession will begin within 12 months has edged up from 30% at the beginning of May to 36% at the start of June. That’s a more than one-in-three chance, marking the second consecutive week that the bank’s proprietary model has reached a new high.

Not surprisingly, the recessionary fears come following news that U.S. employers added just 38,000 jobs in May for the weakest pace since 2010. At the same time, unemployment dipped from five percent to 4.7%, but that’s because more people quit the labor force. The underemployment rate remains stubbornly higher, near 10%. (Source: “The Employment Situation – May 2016,” U.S. Bureau of Labor Statistics, June 3, 2016.)

On top of that, key reports show the services sector is also waning. These are important economic indicators because they account for 80% of GDP. The ISM non-manufacturing Purchasing Managers’ Index (PMI) for May came in at 52.9, missing the 55.3 forecast. While the sector continues to grow, it is doing so at a slower pace. (Source: “NMI at 52.9,” Institute for Supply Management, June 3, 2016.)

According to Markit Economics, the May PMI reading was 51.3, a sliver below the forecasted 51.4. (Anything above 50 indicates expansion.) While the sector is expanding, the pace of growth is one of the slowest since the last recession. The report also showed hiring was contracting and jobs growth was the smallest since January 2015. (Source: “PMI @ 51.3,” Institute for Supply Management, June 3, 2016.)

Again, it’s not a big surprise to learn that first-quarter U.S. GDP limped along at 0.8%. In the fourth quarter of 2015, GDP was just 0.7%. Admittedly, that does suggest growth, just not on the kind of trajectory the Federal Reserve was expecting when it initiated its first round of quantitative easing in late 2008. (Source: “Gross Domestic Product: First Quarter 2016 (Second Estimate),” Bureau of Economic Analysis, May 27, 2016.)

U.S. Earnings Recession

This year has been the worst start for the S&P 500.

Over the first six weeks, the S&P 500 tumbled more than 11%. Stocks tanked on concerns that the biggest economies in the world (China, Japan, and the eurozone) were on the brink of a recession. The free-fall also came just a couple short weeks after the Fed raised rates for the first time in nearly a decade. Clearly, the U.S. economy was not strong enough to support the hike.

Since then, however, the index has staged a remarkable comeback. As of Tuesday, the S&P 500 was less than one percent from its May 2015 closing record-high. But again, the rebound has nothing to do with strong underlying fundamentals; it has more to do with cheap money, improving oil prices, and the fact that the rest of the world is worse off than we are.

Case in point: the S&P 500 is flirting with a new record closing. It’s doing this in the midst of an earnings recession. In the first quarter, the S&P 500 reported a blended earnings decline of 6.7%. This is the first time the index has reported four consecutive quarters of year-over-year declines in earnings since the financial crisis. (Source: “Earnings Insight,” FactSet, May 27, 2016.)

Wall Street does not exactly have a storied history of earnings accuracy. On December 31, 2015, the estimated earnings growth rate for the first quarter of 2016 was 0.3%. On March 31, the blended earnings forecast had turned negative, to a first-quarter decline of one percent. Both were far off the final number. (Source: “Earnings Insight,” FactSet, April 15, 2016.)

The fifth times a charm…

For the second quarter, the estimated earnings decline is just 4.8%. But as we have seen, that will change and probably for the worse. On March 31, the estimated earnings decline for the second quarter was 2.8%. (Source: “Earnings Insight,” FactSet, May 6, 2016.)

Anyway, if the S&P 500 reports a decline in earnings in the second quarter, it will mark the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since the third quarter of 2008 through the third quarter of 2009. (Source: “Earnings Insight,” FactSet, June 3, 2016.)

Global Financial Crisis

The U.S. is not an economic island. U.S. stocks rely heavily on other countries to bolster their bottom lines. In fact, roughly half of all the S&P 500 companies get sales from outside the U.S. Those with more global exposure have been reporting weaker sales and earnings growth than those firms with less global exposure.

At the moment, the global economy is struggling and with more Federal Reserve hikes on the horizon, it is unlikely the biggest international economies are going to be able to rebound on any meaningful level anytime soon.

So, how are the biggest global economies doing? Not stellar. Take the world’s second-biggest economy for example. In China, first-quarter GDP slowed with its lowest quarterly growth rate in seven years (6.7%). Fourth-quarter 2015 GDP was 6.8%. Overall, 2015 GDP was the country’s weakest in 25 years. (Source: “China GDP: Economy slows to 6.7% in first quarter,” BBC, April 15, 2016.)

Japan, the third-biggest economy, is projected to grow at an annualized rate of 1.9%. The central bank, however, continues to maintain a negative interest rate environment and says future easing is possible. (Source: “Japan’s first-quarter GDP seen revised up on smaller capex falls – poll,” Reuters, June 3, 2016.)

The eurozone, the world’s biggest economic region, saw its economy advance at 0.6% during the first three months of the year, but there are growing fears that overall growth will be weaker in 2016 than it was in 2015. The rise in oil prices will reduce consumer spending, which, when coupled with slower overseas growth and a depreciation in the euro, will weigh down exports. (Source: “Eurozone GDP growth confirmed at 0.6 per cent – faster than US and UK,” City A.M., June 7, 2016.)

I understand that a handful of statistics do not equal a recession. However, Wall Street is not like CSI where there is an infallible connect-the-dots system to a conviction. Sometimes, there is more than enough circumstantial evidence that points to a recession.

For evidence of the coming financial crisis, re-read this article.