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 EEM, FXI & 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.