The Global Domino Effect: Are You Ready?
The world is starting to look a lot like 2008. The global financial system is awash in debt, civil societies are wracked by political turmoil, and equity markets are overvalued relative to historical benchmarks. Catalysts for a correction are abundant in America and overseas.
Brexit was a harbinger of the domino cascade to come. In the wake of Britain’s surprise move to exit the European Union, other powerful countries such as France and Italy are embroiled in nationalist fervor that could result in their abandonment of the EU. The emerging markets of China and Brazil face multiple crises as well.
Call it “The Global Domino Effect.” Let’s take a closer look at the key dominoes and how you can protect your portfolio from the chain reaction.
Deutsche Bank says: “Sorry”
In full-page German newspaper ads last Saturday, Deutsche Bank apologized for misconduct that has cost the company billions and undermined faith in the global banking system.
If any one bank represents a domino, it’s Deutsche Bank, the largest lender in the largest economy in Europe.
In the EU’s growth engine of Germany, the scandal over Deutsche Bank and its $42 trillion derivatives exposure is bringing to the fore the ugly balance sheets of foreign banks.
Saturday’s ad, signed by Deutsche Bank CEO John Cryan, stated that the bank’s past malfeasance “not only cost us money, but also our reputation and trust.”
Deutsche Bank’s chief economists recently said that the EU needs to initiate a €150 billion bailout as part of a major recapitalization program for its ailing banks.
Financial institutions in two other major countries also bear responsibility for reckless behavior: China and Italy, the world’s second- and eighth-largest economies respectively.
The boogeyman is going broke…
Let’s start with China, the country that President Trump holds up as an international villain. The big, bad boogeyman of China is actually going broke.
Recent estimates peg China’s troubled credit in excess of $5 trillion (yep, trillion), which represents approximately half of the country’s annual gross domestic product (GDP).
The policy-making mandarins in China’s centralized mercantile economy racked up this staggering debt by desperately trying to stimulate the sputtering economy through poorly conceived infrastructure projects. The government also wasted billions by propping up scores of state-subsidized “zombie” corporations deemed too big to fail.
The debt bubble in China is one of the biggest threats facing global stability today. Adding pressure to China’s overextended banking sector is the country’s devaluing currency, declining stock markets and flagging GDP.
La Dolce Vita turns sour…
And then there’s Italy, land of wine, song… and debt.
Dark clouds are forming over this Mediterranean nation, as the country’s mismanaged economy sinks deeper into the kind of dysfunction for which the Italian government is famous.
The country’s largest bank, UniCredit (OTC: UNCFF), recently announced plans to raise €13 billion euros ($13.8 billion) in the country’s biggest-ever rescue financing, to beef up the bank’s deteriorating balance sheet.
It gets worse. Troubled Italian bank Monte dei Paschi di Siena (OTC: BMDPF) also announced a last-ditch refinancing, as part of a restructuring program that will include new top management, thousands of job cuts, hundreds of branch closings and the jettisoning of toxic loans. The bank is trying to lure investors into contributing €5 billion ($5.5 billion) in new capital. Monte dei Paschi di Siena was the worst performer in a stress test this past summer of EU banks.
A major banking failure in Italy could be imminent, which in turn would spark financial contagion throughout the Continent if not the world.
Blame it on Rio…
Brazil in 2016 experienced its worst recession in more than 100 years, with no relief in sight. Inflation has reached nearly 11%, with joblessness at 7.6% and rising.
The most severe economic downturn in Brazil since the 1930s has deprived Brazilian businesses of workers with jobs and disposable income. As the number of nonperforming loans rises, banks are cutting back on lending, feeding the downward spiral.
Citizens in Brazil have taken to the streets to wage bloody demonstrations against a scandal-plagued government that they feel has betrayed its professed populism and aligned itself with oligarchs. The press is rife with lurid tales of bribery and kickbacks in high places.
What it means for your money…
Jim Pearce, chief investment strategist of Personal Finance, points out that the stock market has traded in a narrow range during the first three weeks of 2017. He describes it as a “tense atmosphere” and warns that potential triggers for a correction abound:
“The longer the stock market sits still, the more likely it is to unleash like a coiled snake when there’s finally a consensus. Several weeks of relative inaction can spring-load the stock market as apprehension builds, usually followed by a big move up or down.
That’s why the first few months of Trump’s administration are so critical. With the stock market near record highs, even a slight misstep could trigger a stampede.”
Jim knows that a fraught investment environment makes careful stock picking more imperative than ever:
“Investors who can’t tolerate volatility have two choices. They can either exit the market entirely or adopt an investment strategy that capitalizes on the opportunities that constant chaos creates.”
Asset allocation: your bulwark against disaster
The “domino crashes” of 1929, 1981, 1987 and the more recent tumbles of 2007-2009 are all examples of situations when investing in only one type of asset was not the wisest course of action.
Several credible research studies have found that that asset allocation explains nearly 100% of the level of investor returns. At the heart of asset allocation is the risk-return trade-off. Many investors make the mistake of setting their asset allocation once and then walking away. It’s not a one-time task; it’s a life-long process of fine-tuning.
In addition to steering our flagship publication Personal Finance, Jim Pearce also serves as director of portfolio strategy for Investing Daily.
For a proper risk-return balance amid today’s uncertain global and domestic climate, Jim currently recommends these portfolio allocations: 35% in stocks and the remaining 65% in cash, bonds, and inflation hedges.
Our in-house advisors also recommend that you invest at least 5%-10% of that 65% in the classic crisis hedge of gold.
Got any questions about the global financial mess and how it affects your investments? Or do you have feedback on our new email layout? We’d love to know what you think! Send me an email: email@example.com — John Persinos
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