How to Invest When Your Country Is Going Bankrupt

 

A few months ago, it seemed as though only Greece was having financial trouble but things appear to have been spreading quickly. Some very credible economists such as John Mauldin have been discussing and forecasting this issue for over a year now and the reasons are multiple: demographic factors mean less workers per retiree, rising health costs, diminishing or stable revenues. Governments around the world have borrowed too much and the recent credit crisis has made the situation very complex. Add to that the reality that is sinking in about the fact that yes some European Union countries will more than likely default on their debt. As if all of that was not enough, the US is playing around with the renewal of its debt ceiling with a deadline of August 2nd. While that deadline would not bring the US in default, it is quite representative that things are going this far after Bush and Obama combined for record deficits that have caused rating agencies to openly discuss a US debt downgrade. That was unthinkable a few years ago.

In a world where the default of some governments is almost certain in the next 5-10 years, what does that mean for investors in those countries? I don’t think anyone truly knows because such large scale government problems have never occurred. Sure, there has been the occasional default with Russia and Argentina being good recent examples. However, we have never lived a scenario where several industrialized nations needed so much help in terms of bailouts, etc. The US and Germany are rich and ready to help, but they have limited resources and saving countries such as Spain and Italy could be beyond their capabilities. There’s also no need to tell you how even the growing possibility of a US fiscal crisis could affect the world economy.

Trading Ideas For An Uncertain Outlook

-Asset Diversification: There is no doubt that if things start to happen, it could go down very quickly. Just think about how quickly Lehman and Bear Sterns went down and it will give you a very good idea. You will have no time to react if governments start defaulting so your portfolio might as well be prepared on any given day. One way to start is to be diversified. Having stocks, bonds, exposures to both local, international and other emerging markets is a good start. Bond exposure should not all be governments and ideally be in a few different currencies/countries.

-High quality corps: When you look at the assets, debts and activities, some corporations seem to be much safer investments than a lot of countries. Tbills are still regarded as the safest investments and many European countries might still be seen as without any risk. However, when you look at fundamentals, companies like Exxon (XOM), many think that in a world where the US was downgraded, Exxon could very well keep its AAA rating as some corporate bonds would become “safer”.

-Inflation Bonds: One thing that could happen to governments that are struggling is for them to start printing money. Among other things that would happen in such a scenario is worldwide inflation pressures. Owning some inflation hedges such as inflation bonds or even better tip ETF’s might prove to be a very good strategy.

-“Hard Assets”: In a world where governments are unable to keep their word, currencies can lose value quickly and what could do well are hard assets such as metals, that can be purchased either physically or through ETF’s, futures, etc.

-Holding Cash Is Not Good Enough: Many worried investors tend to keep a lot of cash when things start to get “iffy”. I would argue that it could be a big mistake. Just talk to anyone that was keeping cash in Argentina when inflation got out of control and they will tell you well that worked out. Staying cash is a good and safe strategy when things go wrong in the market, but not when the actual currency becomes worthless

Any other ideas?

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