Will European Debt Crisis Bring Down U.S.?

by: Todd Feldman

Will the European debt crisis bring down the U.S.? According to our behavioral indicators the answer is no. How do we come up with this answer. First, let us explain how the indicators work. We create a behavioral measure for various markets around the world based on behavioral finance. We also create crisis thresholds. If the measure exceeds the crisis threshold it signals there will be an imminent crisis ahead.

The most recent debt crisis to occur outside of the U.S. to have a significant impact on the U.S., excluding the current one in Europe, was the Asian financial crisis and Russian default. Therefore, we were curious about how our behavioral measures acted during those times. Did they signal a crisis before it actually occurred or was it a contemporaneous measure? Below is a figure that draws out our behavioral measures for Brazil, Thailand, Russia and the U.S. If any of these measures surpasses the crisis threshold it indicates a crisis.

Figure 1: Asian Financial Crisis and Russian Default

Behavioral Measures vs. Crisis Threshold

Click to enlarge

It can been seen in Figure 1 that the behavioral measure for Thailand and Russia crossed their thresholds toward the end of 1996. The Asian financial crisis took place in mid 1997 and the Russian crisis took place in August of 1998. Therefore, the measures were forewarning about crises before they occurred. The U.S. crossed its threshold in August of 1998 which was a contemporaneous response and therefore was not a leading indicator.

This time around we want to examine the European measure to determine whether there is any signal of a crisis in the eurozone.

Figure 2: European Debt Crisis

European Behavioral Measure vs. Crisis Threshold

We find the European behavioral measure is elevated but still below the crisis threshold. As of today our measures are not indicating an European financial crisis.

What to do today? We see value in select emerging markets including South Africa, Mexico and India. For the brave, Indonesia and Malaysia.

Disclosure: I am long EZA, EWW, INP.