John Mauldin: Preparing for a Credit Crisis

This week we turn our eyes first to Europe and then the US, and ask about the possibility of a yet another credit crisis along the lines of late 2008. I then outline a few steps you might want to consider now rather than waiting until the middle of a crisis. It is possible we can avoid one but, as I admit, whether we do (and the extent of such a crisis) depends on the political leaders of the developed world (the US, Europe, and Japan) making the difficult choices and doing what is necessary. And in either case, there are some areas of investing you clearly want to avoid. Finally, I turn to that watering-hole favorite, the weather, and offer you a window into the coming seasons. Can we catch a break here? There is a lot to cover, so we will jump right in.

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You think the world’s central banks and main institutions are not worried? They are pulling back from bank debt in Europe, as are US money-market funds. (Note: I would check and see what your money-market funds are holding – how much European bank debt and to whom? While they are reportedly reducing their exposure, there is some $1.2 trillion still in euro-area institutions that have PIIGS exposure.)

Look at the following graph from the St. Louis Fed. It is the amount of deposits at the US Fed from foreign official and international accounts, at rates that are next to nothing. It is higher now than in 2008. What do they know that you don’t?

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But whether you want to make it 50-50 to 70-30 or (pick a number), there is a reasonable prospect of another credit crisis. So what should you do?

First, think back to 2008. Were you liquid enough? Did you have enough cash? If not, then think about raising that cash now. When the crisis hits, you have to sell what you can for what you can get, not what you want for reasonable prices.

I am personally raising more cash in my business. I usually invest money as soon as I can. Now, I am still investing, and you too should still put money to work in places that you think have the potential to do well in a crisis. Go back and see what worked in 2008 and buy more of it! Long-only funds did not work. Those that were more nimble did.

In the next crisis, opportunities to buy assets on the cheap will grow, so having some cash will make it easier to buy things you want to own for the next 10-20 years, whether income-producing or just something you want for fun.