6 Global Risks that Could Spark a New Crisis

Never before has there been such a dichotomy of opinions emerging from economists. Some predict utter chaos while others feel that government intervention will spark the next bull market. Here I will present some of the risks going forward so that we can all reflect on how much uncertainty there really is.

1) A Revisit of Smoot-Hawley

Scenario: With U.S. unemployment at 10.2% and steadily marching higher, politicians will hear an outcry from their constituents to do something about it. That something usually comes in the form of protectionist measures including trade sanctions. Much emphasis will be put on the Chinese Renminbi and its peg to the US Dollar.

Hedge: Gold, Silver, Swiss Franc

2) Sovereign Default

Scenario: As I noted in "The Relative Strength of Countries", Japan is in dire straits. With a deficit of over 10%, a debt to GDP ratio of over 200% and with aging demographics, Japan is likely the country in the worst fiscal position. A fear of default by Japan would put upward pressure on interest rates in all debt burdened countries.

Hedge: Short Japanese debt, long inflation-protected Japanese debt, short Yen. Secondary hedges would include shorting US and UK debt, buying TIPS

3) Peak Oil

Scenario: A weak dollar, recovering US economy, and strong demand from China threaten to send oil well over $100/bbl. The U.S. consumes about 7 billion barrels of oil a year. That equates to about a $150B additional anti-stimulus at $100/bbl. In addition, the easy supplies of crude oil are dwindling so mining techniques will be crucial in keeping oil prices low. Substitutions such as natural gas and clean energy sources will play an ever bigger part in energy supply.

Hedge: TIPS, commodities, gold

4) Emerging Market Asset Bubble

Scenario: Low interest rates, stronger emerging markets growth, and a continued peg on the Renminbi fuel a flight towards emerging market equities and real estate.

Hedge: Buy calls on emerging markets (EEM), China (FXI) & South Korea (EWY)

5) "W" Shaped Recovery

Scenario: Despite massive fiscal stimulus the United States, United Kingdom and European Unions have faltering growth. GDP in developed nations turns negative due to the withdrawal of stimulus and a shifting consumer focus on repaying debt and building savings.

Hedge: Buy Treasuries, the US Dollar. Short financials and emerging markets.

6) A Strong Recovery and Return to Normal

Scenario: The fiscal stimulus and low interest rates are able to more than ignite global economies. Banks start lending freely, consumers start borrowing, house prices start increasing, and the securitization markets spark to life. The financial "regulation" that was so hotly talked about in 2008/2009 goes by the wayside as the future looks bright and rosie. The market is reinflated for another bust.

Hedge: Buy Call options on Banks (KBE), REITS (IYR), Financials (XLF), and Emerging markets (EEM). Commodities will spike with coming inflation. Wait for the second apocalypse.

Disclosure: Author holds a long-term short position in TLT, a short-term short position in USO, and a short strangle on gold and silver.

Comments

[chris coonan:]

7. Murphys Law
8. Natural disaster...major earthquake in California, etc.

Nov 12 04:31 AM

[Doc 224899:]

7. L-shaped recovery. Short: lawyers, democrats, urban residential property, urban commercial property. Long: gold, silver, gold miners, commodities, rural residential properties, rural agricultural property with fresh water supply, guns, ammo, toilet paper, hand tools.

Hedge: learn animal husbandry and veterinarian skills, learn midwife skills, drop the bitchy attitude, discipline those children, make friends with a blacksmith.

Nov 12 04:54 AM

[Doc 224899:]

8. Several jihadi attacks simultaneously that even Obama can't ignore.
Short: lawyers, democrats, urban residential property, urban commercial property. Long: gold, silver, gold miners, commodities, rural residential properties, rural agricultural property with fresh water supply, guns, ammo, toilet paper, hand tools.

Hedge: learn animal husbandry and veterinarian skills, learn midwife skills, drop the bitchy attitude, discipline those children, make friends with a blacksmith.

Nov 12 05:17 AM

[Mad Hedge F...:]

jgd If I’ve told you once, I’ve told you a thousand times, stay out of those crummy neighborhoods, where the street corners are crowded with high priced stocks of dubious moral character wearing stiletto heels, fishnet stockings, miniskirts, and shoulder handbags. Sure, I know you young traders have needs, think with your hormones, and believe you can live forever. But if you absolutely have to go slumming, at least use some cheap protection. I noticed today that the January 1030 S&P 500 puts were selling at a bargain $19 today. That means for a mere $950 you can buy some decent downside protection for a $55,000 portfolio that takes you all the way out to January 15, 2010. That is bang on the support level that held in the last sell off. If you double top here on the charts and go down for a retest, you double you money. If yearend profit taking causes us to sell off going into the holidays, and we break that support, you make more. If the market melts down the day after we flip the calendar page to 2010, a distinct possibility, then you hit a home run. If the lemmings keep driving this market up every day for two more months, then you lose $900, or 1.72% of your portfolio, pennies, really, against the huge returns you have booked so far this year. It’s a win, win, win, lose pennies trader. I know that the pros that have done for a long time put these trades on without even thinking about it. It’s all about risk control. Since I am a cheapskate, I only like strapping on trades that have a risk/reward ratio overwhelmingly in my favor, and with the volatility index today a bargain 23%, this fits the bill nicely. Buy your storm insurance when the sun is shining.

Nov 12 08:06 AM

[Econ 1:]

Hey DOC I also learned how to make beer (for use as trade after GS triggers the apocalypse by mentioning themselves and God in the same sentence again)! Thats what I call a usefull hedge!

Nov 12 08:37 AM

[Econo:]

compaired with november 2008 and 2009, companies have got rid of their death stocks, making a hughe accounting profit just because of stock movements... And whatever didn't came out of sales came out of the rest of the "costs".

nice tricks, that didn't do shit about their problems.
Let's see what tricks they'll be able to perform next year...

abra cadabra salabim salabam!!

Stimulus number 2 and 3 will cause a devaluation on the $ and because almost no company has any stocks left, they won't be able to take advantage out of it, making them very weak and adding even more on the inflation risks on commodities.

On the other hand. If we compare this crisis with the depression, I notice one big differnence: THESE DAYS, THERE ARE A LOT MORE SMART GUYS IN SUITS to FIX the problems at hand.

So if you want to know if the future is going to be good or bad, just take a dice and mark the numbers. Your guess is as good as any.

Nov 12 08:40 AM

[vpratt51:]

Sorry, but these lists always remind me of Rumsfeld's list of unknowns before we invaded Iraq. No nukes or poison gas used. No human waves. In fact, only one of them did come true. The unthinkable one....not all Iraqis were happy that we invaded. Odds are, the greatest problem will be from the unexpected, such as Tralfamadorians inviting us to (be) lunch.

Nov 12 09:43 AM

[JMBishop:]

I go with option No. 6: greed is ever resilient.

Nov 12 09:59 AM

[cyclingscholar:]

"Never before has there been such a dichotomy of opinions emerging from economists."

You aren't SERIOUS, are you?

Nov 12 03:03 PM

[Ben Gee:]

Developing countries will be the next area of growth. We should go along. We do not want to be on rewind when others are playing. Some, China for example, are on fast forward, we should catch a ride with them. If we do not move, we will be left behind.

Nov 13 06:11 AM