Like you, I’m a value investor, so when I pick up my binoculars and search for investment risk factors I’m looking out at time horizons greater than 6 months, for issues which will have a prolonged impact on  holdings. Assessment of the worse case scenarios is an on-going process as I attempt to put a face on the risk factors and distinguish between them.


As I’m globally diversified, I look for issues with possible implications for international financial markets. I use the findings of the assessment to ensure that I’m properly positioned for those issues and mentally prepared for possible negative events.


Being Forewarned

To set the overall context. The economic recovery resulting from the 2007-2008 financial crisis is shaky.


The recovery is projected to strengthen in 2017 and beyond, driven primarily by emerging market and developing economies, as conditions in stressed economies start gradually to normalize. But uncertainty has increased, and risks of weaker growth scenarios are becoming more tangible.

The IMF WEO, April 2016


If the advanced economies of the U.S. and others was in better shape then the implications of events caused by the following risk factors could be muted but sadly, as investors, we don’t have that luxury.


Downside Investment Risks

Here is what we know, and in no particular order:


1. The EU, as a block, is the world’s 2nd largest economy and is mired in economic, social and political challenges. Where to start…

On June 23rd, the UK will hold a referendum to decide if it should leave the EU. The UK is the 2nd largest economy within the block and contributes just over 17% of GDP. If the UK were to leave, as in any acrimonious divorce, there would probably be a prolonged period of uncertainty. The latest polls show a lead of 8% among voters that want to stay in the EU, 54%, and those who want to leave the union, 46%.

Euro Zone banks are struggling with new regulatory requirements on leverage. The ability of the banks to lend, their dividends to shareholders and profitability is suffering. The EU banks, as their American counterparts, are also dealing with exposure to debt from energy companies. To put a cherry on the cake many banks, such as Germany’s Deutsche Bank, are exposed to Greek debt. Yes, the Greek financial crisis is still alive and kicking. A new set of Greek bailout talks is presently underway.

The massive migrant influx into Europe threatens the unity of the Euro Zone and the EU. The issue has implications for its labor markets, freedom of movement for citizens and trade. Eurosceptic political parties, with a touch of xenophobia, have been making inroads with voters. Parties opposed to the EU presently hold just over 10% of the seats in the European parliament.

2. Japan is the world’s 3rd largest economy and has been in a deflationary cycle for decades. Public debt now constitutes over 230% of GDP. There is virtually no inflation, even with the central bank policy of negative interest rates. There are mind blowing amounts of central bank stimulus being pumped into the economy. The Bank of Japan (BoJ) has been backstopping Japanese equity by buying securities on the open market and now owns 1.6% of the total capitalization of all Japanese listed companies.

The monetary authority’s exchange-traded fund purchases have made it a top 10 shareholder in about 90 percent of the Nikkei 225 Stock Average, according to estimates compiled by Bloomberg from public data. It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion.


Nothing seems to be helping revive the economy and Haruhiko Kuroda, the President of the BoJ, has recently hinted of increasing monetary stimulus and the asset purchase program. The economy is on life support. This can’t be good.

3. The Chinese government’s re-alignment of the economy to a market-based system has had on-going widespread consequences throughout the country. Compounded with an economic slowdown the Chinese government’s implementation of its new policies has international implications.

4. Low commodity prices and low global demand are aggravating the problem of lack of economic growth in many emerging markets. Financial instability in these economies, especially in light of Fed decisions, may cause chaotic capital flows and generate a global contagion effect, as we’ve seen in the past.

5. Low energy and commodity prices are not helping the inflation picture. Despite massive central banks’ stimulus, inflation in most advanced economies is, for all intents and purposes, non-existent. At some point, there will be a reversion to the norm. The hope is that it will not be an uncontrolled return to normal.

6. The collapse of oil prices and the effects of energy industry defaults and bankruptcies on the financial system are unknown.

7. In the Middle East, lower oil prices are putting stress on governments’ budgets as they have less money to spend on subsidies and social programs. Civil unrest may result unless new and improved social compacts are implemented. The Persian Gulf area is sensitive and crucial to global energy security as a significant portion of the oil is not only produced there but moves by its maritime routes.

8. The consequences of central banks unprecedented stimulus measures, negative interest rate policies and their unwinding are completely unknown. Keeping in mind that the Fed has not terminated its asset purchase program. It’s still purchasing mortgage-backed securities and Treasuries with the interest it earns and rolling over the principle on the securities it owns which were purchased during its more active phase of QE.


There are also Unknown-Unknowns

The downside risks are substantial and, of course, these are the ones we know about. Anyone one or combination of them can cause prolonged harm. The potential for loss seems high. I will re-look at my asset allocation and diversification strategy and give an update in future posts.


I would really like to hear about what you see as risks in this environment. I look forward to your feedback. You can write in with your comments and share: Facebook.    Google+.    LinkedIn.    Twitter.


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