Why This Downturn Is Different

During the 2008 Credit Crisis, many institutional investors turned to emerging economies like China as an alternative and for the most part, it paid off.  From 2008 to 2010, there was an overwhelming sentiment that the Emerging economies had decoupled from the Developed economies. Furthermore, due to China’s increasing consumption, commodity prices and corresponding commodity based economies such as Australia and Brazil were able to piggyback on the perceived decoupled growth. 

While the West has suffered, China’s reported GDP annual growth rate has ranged between 9.2% and 10.4%.  The perception of decoupling has held so far but I have concerns that the global economy is going to experience a shift that may surprise many.  China, despite its attempts to maintain an image of constant double-digit growth, is currently experiencing a soft landing and consequently, it appears that many of the industries and countries that piggybacked on their growth are experiencing likewise.  

“A rising tide lifts all boats” and unfortunately, the opposite rings true as well.

China is not as decoupled as the global economy had hoped.  China’s forecasted growth is 8.2% for 2012 and most analysts don’t perceive any rebound in the near future.  The reason for this is because the current Euro Crisis has demonstrated that China is not as self-reliant as many hoped. 

The question is what impact will this have on the global investment environment? 

This is yet another reason for why there is currently a global flight to safety which means that everyone is seeking what they perceive as the safest means of capital preservation.  Investors are currently paying the German, Dutch, Austrian, Finnish and Danish governments for the privilege of placing their funds with each respective treasury and it appears that UK may be joining the club.  UK yields on 2-year government bonds appear likely to turn negative as investor demand for low-risk investments continue to increase. 

This means that investors are willing to incur a guaranteed nominal loss in lieu of making an investment that could go either way and bear the uncertainty associated with such investment.  This is unprecedented.

Just yesterday, the VIX (Volatility) Index, which many refer to as to the “Fear Index” was at its highest all year.  The VIX is a gauge of investor sentiment.  Warren Buffett has said time and time again “Be fearful when others are greedy and be greedy when others are fearful.”  According to Buffett, now would technically be the time to invest. 

Is it?

In my opinion, for the most part, it isn’t.  And here’s why:

-       The Euro Crisis is going to resolve itself any time in the near future and will most likely get worse before getting better

-       The libor scandal will have far–reaching implications and will most likely negatively impact the profitability of the banking sector.  Consequently, this will eventually further tighten an already struggling borrowing market

Yet, in my opinion, gold has had its run, defensive equities are overvalued and treasuries cannot be priced any cheaper. 

Where should a savvy investor invest their hard earned capital without bearing unnecessary risk?

Good question.  Let’s revisit the topic in a few days and I will provide you with my thoughts.