It’s been ten years since the financial crisis started to unfold, so naturally, everyone wants to know where, when and how the next one will start. To this end, Deutsche Bank has published a study in which its strategists identify a number of potential key causes of the next crisis.
The report included the usual suspects – fears over China’s economy, geopolitical concerns and concerns over valuations for financial markets – in the case of both equities and bonds.
China, Deutsche analysts worry, is a key vulnerability due to the country’s rapid credit growth. Its ‘insatiable demand for debt fuelled growth,’ they noted ‘compounded by a hugely active shadow banking system, as well as an ever-expanding property bubble’ raises concerns that the economy may face a hard landing and ‘send shockwaves through the world's financial markets.’
For now, however, ‘the economy has seemingly defied the odds,’ Deutsche analysts added.
Also on the radar of Deutsche Bank’s analysts was populism. While the study includes the usual nods to the both Brexit and Donald Trump, the analysts also noted risks coming from Italy. They note Italy is a ‘country nearing an election and with high populist party support, with a generationally underperforming economy, a comparatively huge debt burden, and a fragile banking system which continues to have to deal with legacy toxic debt holdings ticks a number of boxes to us for the ingredients of a potential next financial crisis.’
However, what really stands out about the report is its research on global asset prices.
According to Deutsche: ‘We’re in a period of very elevated global asset prices – possibly the most elevated in aggregate through history.’ Yields on bonds, they note, are at their lowest ever point.
To what extend equities alone, are overvalued, the bank noted, is harder because ‘they are a real asset and therefore today could be a good time to buy.’
However, the report’s authors added: ‘Current valuations are certainly stretched’ Valuations are ‘approaching the peaks of 2000 and 2007 and are in line with the most stretched valuations from the 1930s on this metric and higher than the 1929 crash point.’
The current high valuation of global assets, should they ‘succumb to gravity’, pose a threat to the global economy. While there are no obvious triggers for historically high global asset valuations to correct,’ the report notes, ‘while they remain this high there is always a risk of a sudden correction that could be destabilizing to a financial system and global economy that seems to require such elevated asset prices.’
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