Recent events in the financial world could be early warning signs of a global crisis. But investors who are prepared for it can grab the opportunities that arise. Author Tariq Alrifai discusses some of them with Personal Wealth.
TARIQ ALRIFAI, author of Islamic Finance and the New Financial System: An Ethical Approach to Preventing Future Financial Crises, believes we are approaching the tipping point of another global financial crisis. Recent events around the world may appear to be isolated cases, he says, but they serve as warning signs.
“Look at what happened with the Swiss franc in January. Have you seen the currency of any developed country fluctuate 30% in one day? That has never happened. Look at what happened with German bonds recently — they spiked. Isolated incidents?
“Look at what is happening with some sovereign bonds and negative interest rates. The UK, for example, said that since it started keeping records on inflation, it has never seen deflation reach this low [its consumer price index recorded a decline of 0.1% in May, the first annual drop since 1960].
“Then there are the rising number of corporate loan defaults in Spain, Italy and Portugal. You can’t keep having all these isolated incidents. They are all linked together.”
Tariq, who is head of investor relations at Kuwait Finance House in Kuwait, has been working in the Islamic finance industry for more than 18 years. His areas of specialities include Islamic funds and investment products.
He believes that the financial crisis could happen as early as this year. The root cause of the problem, he says, is the increasing debt in the financial system, which is heading towards unsustainable levels.
According to McKinsey Global Institute, global debt amounted to US$199 trillion (RM735.5 trillion) last year, making up 286% of the global gross domestic product (GDP). This is a stark increase from US$142 trillion in 2007 (269% of global GDP). Japan was the highest debtor last year, recording 517% debt-to-GDP levels, while the levels in China and the US were 282% and 269% respectively.
“It all goes back to too much debt, even though debt is required for economies to grow. Central banks know this, which is why they are handing out easy money and pumping in liquidity [with quantitative easing programmes],” Tariq tells Personal Wealth in a recent interview.
Since the 2008 global financial crisis, central banks have introduced quantitative easing (QE) programmes, or the buying of government bonds, in the effort to increase liquidity in markets and lower interest rates. In turn, they hope banks will use this to lend more money and spur economic growth. This strategy may have worked in the US, but not lately. According to the Velocity of M2 Money Stock data provided by the Federal Reserve Bank of St Louis, the velocity ratio hit a record low of 1.498 in January (see chart).
“This money is not being used, and you can tell that by the velocity of money, which has been dropping,” says Tariq. In his book, he notes that “banks are hoarding money and not lending it out; thus, the more QE is used, the more the velocity drops, to the Fed’s frustration”.
While subprime mortgages triggered the last financial crisis, anything could spark the next one. One indicator is the increasing number of share buybacks by listed companies in the US. According to data provided by money flow tracker TrimTabs Investment Research, the value of share buybacks by companies in the US hit US$104 billion in February. The value is the highest since TrimTabs began tracking data two decades ago.
Meanwhile, data released by FactSet Research in March showed that companies on the S&P 500 Index spent US$564.7 billion on share buybacks — an increase of 18% year-on-year.
Tariq says investors will be hit harder in the next financial crisis, owing to the higher number of share buybacks. “I feel bad for equity investors. Corporations have increased their stock prices with share buybacks. How do they afford to buy back shares? They borrow money because it is so cheap.
“In the US for example, if you look at the small-cap stocks, they are not hitting any records. It is the S&P 500 and large-cap ones that are because they are the ones borrowing to increase the stock price.”
As the debt levels increase, so do the levels of risk and fragility in the global economic system. “Investors want to see an increase in returns, and the way to do that is to leverage debt. [But when] you increase debt and returns, you are also increasing risk and volatility,” Tariq says.
The debt issue will see its end soon. This time, the man in the street will be harder hit for it. “This time around, it will be more severe because subprime back then was the homeowner — the average person.
This time, the subprime is the governments,” Tariq says.
“Who took on the burden of the debt? They had to keep the debt machine going. Consumer debt is relatively flatter now, corporate debt is up a little, but what is up a lot is government debt.”
If previous crises are anything to go by, investors who are prepared can grab the opportunities that arise following the crisis. “Anyone with liquidity or cash to invest were getting assets very cheap [post-crisis] and buying distressed properties and companies because prices were low.
Cash will be king again. My favourite investment is cash,” Tariq says.
By holding on to cash, investors will have the liquidity to invest again if the market crashes. “The stock market is definitely due for a correction. I don’t want to speculate, but my gut tells me it will be a massive one. And the best time to buy is during a crisis,” he says.
With his extensive background in Islamic finance, Tariq is a strong believer of holding on to investments that are tied to physical assets. He recommends holding on to physical assets like property — but only if investors already have full ownership of them.
“Real estate is a great investment even though values will probably fall during a financial crisis. But it is a great long-term investment, especially if it generates income.
“However, real estate investment in a downturn only makes sense if it is mortgage/debt-free. If you have real estate that has a mortgage, it will be useless as your equity will be wiped out. This is similar to what we saw in the US with homeowners having underwater mortgages.”
Real estate investment trusts (REITs) are also good investments, Tariq says. “As long as the investment owns the real estate, you won’t be investing in debt. [Avoid] real estate developers as their stocks [typically] come with a lot of debt.”
Commodities are also on his buy list, as prices have dropped. “The commodities bubble has already burst. Gold, silver, iron and copper are down. They peaked in 2011 and have been going down since. If my outlook is correct, they will continue to go down. But commodities are still commodities. You can buy, sell and trade them. Eventually, they will go up again,” Tariq says.
“Even if we see a crisis, like in 2008, gold might go down. But during a panic, you will see a flight to safety in gold and silver.”
Apart from high-grade bonds, he recommends avoiding the asset class altogether as they are too risky to hold on to in this environment. “Defaults will start at the bottom and those are the riskiest ones. Then, people will rush into the best of the best in bonds. But if you are already holding high-quality bonds, then you would have made a profit.”
Tariq believes that an investor’s portfolio should still look diversified but without complex investment instruments. “If your financial adviser takes too long to explain [the product] to you, don’t invest in it,” he says. But overall, he advises investors to be overweight cash.
“Otherwise, take a look at negative interest rates [in developed markets]. It is hard to believe, but investors are willing to pay to keep their money safe.”
This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on June 8 - 14, 2015.
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