The world is in a crisis; a global debt crisis that pre-coronavirus amounted to $197 trillion, with $22 trillion belonging to the U.S. There has been an upsurge in global debt owing to governments which has directed people's attention towards handling and mitigating the effects of the global pandemic and the suspended economies. In the U.S. alone, millions who've lost their jobs will have to apply for relief, and government bodies will deal with a looming immigration crisis and a reduction of funding to noble causes, such as global warming.
Not completely unexpected, economists and financial institutions saw the debt crisis coming. A World Bank Annual GEP
report
confirmed that the current global debt crisis had signs similar to the previous major global debt crises. An increase in global debt and past economic trends all point to a looming market crash that will have an impact on investors. Nevertheless, there are multiple strategies that Brown Investors recommends to prepare.
Signs of a Declining Market
The first step in preparing for a market crash during a debt crisis is to first see the signs of a declining market. Because all market crashes are apparent, these signs will prepare you so that the next market crash won't catch you unaware.
An All-Time High Global and Corporate Debt
The first thing to look for is global debt. The current global debt stands at
$281 trillion, which is 355% of global GDP. This amount will only continue to rise due to outside factors such as Covid-19. Additionally, a recent
UNCTAD report
shows the global corporate debt stands at $75 trillion, double the amount recorded in 2008.
According to a recent
CBO report, the U.S debt stands at 102% of GDP, with a fiscal deficit of $2.3 trillion. During this time, foreign countries such as China have accumulated U.S treasury securities that have amounted to
$1.08 trillion, 4% of the total U.S debt.
Loose Monetary Policies
The second thing to look for is a loose monetary policy. The U.S. Federal Reserve implements various monetary policies during different economic moments. For example, during an economic downturn, the Fed will implement a loose monetary policy to increase the money supply and stimulate the economy.
For the average person or small business, you can identify the signs of a loose monetary policy such as the availability of credit and decreased interest rates on loans and credit.
Sophisticated analysis is crucial to gauge when to implement a loose monetary policy accurately. If not done right, it could result in currency devaluation, high unemployment, high inflation, or an
overheated economy, in turn resulting in a market crash such as the junk bond market crash.
Short Term Behaviors of Credit Markets (Chance for A Credit Crunch)
The final thing to look at is the credit market. Financial institutions may face strict measures such as increased capital requirements from regulatory bodies or suffer market losses due to borrowers defaulting on credit. When this happens, the financial institutions increase their lending rates to distribute lending risk and cut back lending, resulting in a credit crunch.
A credit crunch can decrease borrowing, growth, and expansion, causing numerous businesses to shut down. In addition, during a financial crisis, a credit crunch curtails economic recovery, leading to a market crash.
How to Hedge Against a Market Crash
While you can lose a lot in a market crash, the following ways can minimize the effects of the market crash on your investments.
Diversify Your Portfolio
When investing, you should look to diversify your portfolio by owning several investments across different industries. Instead, diversify your portfolio by mixing various assets, such as shares, cryptocurrencies, and commodities. This will help to reduce risk while maximizing profits.
This doesn't mean you should over diversify. Investment experts such as Warren Buffet confirm that over-diversification can lead to minimal returns on your portfolio. So, the rule of thumb, limit your investment in a single stock to a 10% allocation.
Put Options
A put option is a contract that gives you the right, but not the duty, to sell an underlying security, say shares or bonds, at a predetermined price (strike price) within a specified time (on or before the contract's expiration). Put options increase their value as the value of the underlying stock decreases, and that's when you can sell and make a profit.
Exchange Traded Fund (ETF)
An ETF is an investment fund made up of assets, such as bonds and stocks. ETFs track market indexes, such as NASDAQ or the Dow Jones, and can be traded during the day as securities exchange at fluctuating prices. By buying into ETF's you become better diversified and allows you to be a passive investor.
Are You Ready If the Market Crashes Again?
A market crash can leave your investments in tatters. If you are a first-time or even a seasoned investor, these signs will guide you into hedging your assets against a market crash. For more invaluable investment advice see what our founder has to say about getting started with investing and understanding market dynamics to optimize your portfolio (even in the midst of a crisis or major event).
Check out her guest spotlight
on the Connecting with Careers podcast today!