Historically, recessions begin when central banks overshoot their rate hikes, tightening credit to take the steam out of growth. The Federal Reserve started hiking rates in 2015. The European Central Bank has signaled plans to dial down its accommodation programs. For investors, that means it’s time to worry about the return of—not just the return on—your money, according to Kane and Rivelle.
In other words, they say, you might want to consider an insurance policy. Harvest some profits from stock gains, shift fixed-income holdings away from high-yield and emerging-market debt, and add ballast to portfolios with higher-quality bonds—even if a downturn remains years off.
“I’m highly confident my house won’t burn down in the next year, but I still have insurance on it,” Rivelle says. “The challenge,” Kane adds, “is to not pay too much for insurance.” — John Gittelsohn
A Collapse of Confidence
The European chairman of Houlihan Lokey Inc., David Preiser, is an alchemist of sorts. He picks up pieces of broken companies and makes something out of them. And what he sees as he focuses on the future isn’t pretty.
“Until 2008, people thought debt problems were confined to specific sectors,” Preiser says. “But when the bubble burst, trouble popped up in unexpected areas.” People assumed certain sectors were very liquid, he recalls, only to learn that being unable to sell in an illiquid sector could also bring down prices in more liquid ones. In other words, markets were more correlated during a crisis than previously thought. “Financial complexity brings prosperity but also increased fragility,” he says.
Similarly, the bankruptcy of Lehman Brothers brought back the issue of counterparty risk—something people had almost forgotten. “Since then, it’s been a long and slow recovery,” Preiser says. “But the underlying problem remains: The entire edifice is built on confidence, and that can evaporate pretty quickly. The next global crisis will stem from failure of confidence somewhere.”
Preiser thinks the European Union and the euro zone will be among the likely triggers. While the EU has weathered a number of crises and even stared into the Greek abyss more than once, something changed on June 23, 2016, when the U.K. voted to go its own way. “For a long time, Europeans blinked and stuck together,” he says. “But with the Brexit vote, one of the main tenets has been undermined.”
Elections and public opinion on the Continent seem to indicate otherwise, Preiser acknowledges. His point is that when the euro zone’s next crisis happens, there will be less confidence that the group will stick together. “So far, European countries have chosen to stay in,” he says. “But in the long term, the EU is not stable as constructed; the essence of the problem is that you have a monetary union without fiscal union. If confidence is shaken in the European structure, markets will sell off, big time.” — Luca Casiraghi
Keeping the Lid on Japan
Fiscal weakening, as ever, poses risks, says Ryutaro Kono, chief Japan economist at BNP Paribas. If no decisive action is taken to fix the nation's fiscal woes, he says, the yen could weaken to well beyond 150 per dollar—compared with around 111 now—and inflation could accelerate to 4 to 5 percent or even higher, from the current 0.7 percent.
The good news is that the inflation spiral might not take off until around 2025. The period around that year is key, Kono says, because by then baby boomers will be 75 or older, with medical and nursing costs rising sharply. “Even if by a stroke of good luck we’re able to make it through 2025,” he says, “by the time baby-boomers turn 85 in 2035, nursing costs will surge.”