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Executive Insight – New rules for a new environment

by Michel al-Absi

The Great Recession of 2008 led to a meltdown in both credit and equity markets and the collapse of massive financial institutions, chief among them being Lehman Brothers. Governments had to intervene in order to avoid a complete meltdown of the global financial system — what many referred to as ‘the end of the world’ — but the sense of security and stability this allowed was a temporary veneer which is now quickly evaporating to reveal that the crisis is still boiling.

The great economies of the world are suffering from grave fiscal and structural imbalances with no long-term remedy apparent.

The United States economy is struggling, and the S&P’s downgrade of America’s once coveted AAA credit rating highlights the uncertainty surrounding whether Washington will be able to find a solution to its enormous fiscal challenges. The $787 billion economic stimulus package, passed in February 2009, did not have the desired outcome of a sustained boost in the economy, while the gridlock in government resulting from the power struggle between Republicans and Democrats is only becoming more entrenched the closer we get to the US presidential elections in 2012. These harbingers of misfortune — insufficient fiscal policies, political conflict, a raised debt ceiling and the downgrade — are undeniably pressuring the US dollar, once regarded as the most solid of shelters in times of crisis.

The Eurozone also faces a severe debt crisis, with several members having their credit ratings battered, while European policymakers are being forced to intervene to protect banks from collapsing as a result of their exposure to the debt of vulnerable countries within the union. 

Greece is on the edge of default; while many would argue that this will not occur, the sheer possibility that it might default is significantly pressuring the Eurozone. Italy, the Eurozone’s third largest economy, has the third largest sovereign debt market in the world. Just to put things into perspective, Italy has $2.6 trillion of sovereign debt outstanding and there is only $350 billion left in the European Financial Stability Facility — the euro rescue package. The European Central Bank (ECB) announced that it is tightening the amount of government bonds it purchases. Expressions of hope that a permanent solution is in sight are ubiquitously absent.

The ECB’s strict conditions on a bail-out, its increase in idle cash — due to cautious banks refusing to lend to each other — and the possibility of a sovereign (Greek) default are creating a great deal of uncertainty in the Eurozone. A default in the Eurozone would be catastrophic to anyone exposed to European banks holding government bonds, and thus a significant blow to any hopes for a recovery of the global economy.

It stands to reason that in the current geopolitical climate, investing is becoming an increasingly unnerving venture, with trustworthy investments scarce and safe havens almost nonexistent. Even gold’s volatility and constant price fluctuations are pushing risk-averse investors to question its safety. Gold hit a high of $1,921/ounce on September 6, 2011, and within a period of three weeks fell sharply to $1,532/ounce.

Many major economies are suffering from anemic growth, corporations are still struggling, overall bank profitability is decreasing, money supply in Europe may come to a halt, a major default is not farfetched and the traditional safe havens are being stripped of their security. The dominant currencies of the world are battling each other on who is weaker rather than stronger. As investors, we find ourselves with no truly safe grounds for our investments, but the rise in uncertainty has led to an increase in volatility, a heaven for speculators. The current environment is favorable for investors willing to take risks. The rules of the game have changed, and so should the investor.

Amidst the turmoil and confusion lies an opportunity in disguise: “Be fearful when others are greedy and greedy when others are fearful,” is the famous advice of Warren Buffet; and these are indeed fearful times.

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Michel al-Absi


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