Regular readers know I am all about finding the key risks in the markets and sidestepping them. Most investors are too busy trying to find the next great investment to understand that it’s equally important to avoid the next great disaster. After all, the ugly maths behind stock market losses shows that too often, protecting the downside pretty much takes care of the upside.
In this week’s letter, John Hussman cited his partner, Bill Hester’s excellent list of 5 risks in 2012. I’ve attached each with a brief snippet. It primarily covers Europe, but I would recommend reading the full piecenonetheless:
1) The Persistence of Wide Spreads Among European Debt – Even if Bond Holders are ‘Rescued’
There are two components of the European credit crisis – debt levels and economic growth prospects. While the conversations to this point have leaned mostly toward reducing debt levels, economic growth prospects and the overall viability of a common currency will likely get a closer look this year, especially as Europe heads for recession.
2) Sovereign Debt Rollover Risks
When the history of the European Credit Crisis is written, it’ll likely be in two parts. The first part will cover the debt crisis of the smaller European countries – mainly the woes of Greece, Portugal, and Ireland. It will cover Greece’s admission that its accounting didn’t add up. And how Ireland’s bad bank debt was turned into sovereign debt – which tripled its debt to GDP ratio in just three years. It will also cover the trajectory of peripheral sovereign bond yields in the face of investor uncertainty, where yields were first pushed above seven per cent, and then eventually to much higher levels, forcing a rescue program.
3) The Depth of Italy’s Recession
It would be difficult to overemphasize the importance of Italy retaining access to the bond markets, and mitigating further losses in its sovereign bonds. According to the Bank for International Settlements, foreign claims on Italian debt total $936 Billion – that’s larger than the combined foreign claims on the debt of Portugal, Ireland, and Greece. And core Europe is long a mountain of Italian debt. French banks, for example, hold 45 per cent of Italy’s liabilities. Much more is at stake than France losing its Triple-A rating if Italy moves from a liquidity concern to a solvency concern.
4) The ECB, LTROs and European Bank Funding
Will the ECB’s three-year long-term refinancing operations (LTRO) work as a stealth quantitative easing program? Will banks borrow long-term funds from the ECB and turn around and buy sovereign debt? That’s the hope. But there are strong tides of data pushing back against this idea.
5) Widespread Global Slowdown
Risks exist outside of Europe, too. Leading indicators suggest that the risks of a synchronised global downturn are building. (See John Hussman’s recent discussion on this topic: When “Positive Surprises” Are Surprisingly Meaningless . ) The year-over-year changes in the OECD’s Composite Leading Indexes for the United States, the United Kingdom, Japan, and Europe have all turned negative to varying degrees. Of these, the OECD’s index that tracks Europe’s major economies is declining at the fastest pace (-6.5), with the 12-month change in the US index falling just below zero in the latest release of the data.
Read the full piece here.
Source: Hussman Funds