Every investor dreams of making that one big financial hit which sends him right into luxurious retirement. The quickest way to do so is by shorting a financial crisis, but how to recognize impending economic breakdowns? A study by the European Central Bank in 2012 distinguishes 6 major indicators which are likely to predict financial turmoil. These are 1) domestic credit to the private sector, 2) increase of government debt, 3) current account deficit, 4) Foreign Direct Investment (FDI) Inflow, 5) a fall in housing prices and 6) a fall in stock prices. They distinguish domestic credit to the private sector as he key indicator for financial crises. The other indicators are very short-term indicators and may come too late such as the fall in stock prices, which is what you want to play into in advance. So let's take a deeper look into the domestic credit indicator.
The main advantage of the domestic credit indicator is that it can predict crisis almost four years in advance, whereas the other indicators are very short-term indicators. So let's see which countries have seen a slump in domestic credit to the private sector (as % of GDP) in the past years and which countries saw some growth. It should be noted that every mentioned country had a stable trend where year on year growth was either always positive (table 1) or always negative (table 2).
As you can clearly see, it's Europe that is in danger. Other regions seem to do just well. Let's take a deeper look to those countries that experienced more than a negative 20% change. Two indicators, high Debt-to-GDP and high FDI inflow indicate crises will be more severe. The table below shows scores for these indicators and shows Ireland is in major danger of severe crisis.
So, we've established Ireland as a potential danger. For completeness sake let's also take a look at the Irish housing market and stock market development. The housing market seems to be rising in Ireland, with a 7.4% change year on year during the first quarter of 2016. The Irish ISEQ Index marks -9.88% Year-To-Date, which can be somewhat troubling. However, over the last 5 years the index has seen a significant rise.
In conclusion, we've been looking at crisis indicators and Ireland is one of the most vulnerable for a financial crisis. The most important indicator, domestic credit to the private sector, looks very troubling. Also, debt-to-GDP and FDI inflow are worrying aspects for Ireland. There is also some light for Ireland, as the housing market is quickly recovering. Still, the danger for a financial crisis in Ireland looms.
