One of Europe's major financial institutions, the Société Générale, in a recent study "Worst Case Debt Scenario" highlighted on the risk of a possible government debt induced crisis that could lead to another global economic collapse.
According to their worst case scenario, one's investment profile should consist of:
-Sell the dollar as a declining dollar could provide a means to reduce global imbalances.
-Positive on fixed income as rates would fall in a Japanese-style recovery. Prefer defensive corporates (telecom, utilities) which have the lowest risk of transitioning into high-yield and should perform well in a more risk averse environment.
-Sell European equities as markets have already priced an economic recovery in 2010e. Under a bear scenario, this optimism could be dashed once restocking is over and fiscal stimulus (especially for the auto sector) has dried up.
-Cherry pick commodities given the diverse nature of this asset class. Agricultural commodities would probably fare best, but are difficult to forecast given high exposure to weather conditions. Mining commodities (particularly gold) are also a hedge against a softening dollar and could be favoured by persistently strong demand from emerging markets, particularly China.
I really don't share the parallels of Japan's experience as the 'right' model for the next crisis and would lean on a highly inflationary backdrop or a debt default.
Nevertheless, like socgen, we are hopeful for a miracle from extraordinary economic growth in emerging markets, based on free trade or globalization to help ease on such imbalances. But internal policies matter.
The complete report shown below:
SocGen - Worst Case Debt Scenario
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