Each-way bet on the four horsemen of the financial apocalypse

The Four Horsemen of the Apocalypse might seem like an extreme metaphor to describe the outlook for Australian investors, but history suggests financial crises are preceded by a standard and repeating set of four indicators.

They are: asset price inflation, particularly real estate; rising household leverage; outsized borrowings from abroad reflected in a sequence of gaping current account and trade deficits; and slowing economic output.

It does look like Australia could score four from four when considering these factors, and that will present opportunities.

And if you believe after 25 years of uninterrupted growth, a modern and sophisticated economy like Australia’s is immune from a financial/banking crisis, remember the last one had its epicentre in the United States, where that country’s arrogance about its financial and regulatory systems’ robustness arguably laid the foundations for the GFC.

In the accompanying video, we analyse each of the “four horsemen” that could be harbingers of investment doom and opportunity, including excessive debt.

There is always, and without exception, one common theme to the vast number of crises the world has experienced: excessive debt accumulation.

And it makes no difference if debt is in the hands of consumers, businesses, banks or governments. Australia’s household debt as a proportion of GDP, at 206 per cent, is currently at historically high levels, and is one of the highest levels in the world.

Studies show that when housing booms are accompanied by sharp increases in debt, the risk of crisis is significantly elevated.

It’s impossible to forecast with certainty what will happen next, but it is clear that in the long run investors will make much more money being invested in businesses than in bonds or cash or property at these prices.

Investors should be doing three simple things to position themselves intelligently for potential future shocks. And they will be well served when they listen to Mark Twain who said, “When you find yourself on the side of the majority, it’s time to pause and reflect”.