System risk, or the risk that the entire financial system will cease to work, is on the minds of many of our clients who invest with the intention of preserving capital and earning enough of a premium over inflation to achieve their financial goals. Rick and Carl mention worries about system risk in our current market review and serious analysts keep a close watch on risk spreads as early warning signals that another “2008-like” episode may reappear. That’s why the July Gloom, Boom, and Doom Report by Marc Faber caught my eye this weekend. We value Faber for his contrarian views, his highly intelligent analysis, and his multi-national view of global finance. As you might expect from the title of his newsletter, Faber is famously bearish on the long-term state of the financial markets. This month he reports on a discussion he was invited to participate in that included other well known and highly respected bearish analysts – Gary Shilling, David Rosenberg, and Nouriel Roubini. With these four guys in the room I hope there weren’t any sharp objects around for listeners to put themselves out of their misery. These analysts are not “wacko” bearish, but highly intelligent bearish...the kind of bearishness that you have to take seriously.
What caught my attention was that for all of the discussion about double-dip recessions and stock market declines back to the old lows of 666 on the S&P 500 Index or lower, there was no discussion of the financial world coming to an end. Most system risk discussions nowadays are split between the camp that says in a massive deflationary spiral interest rates go to zero and paper money becomes worthless as governments are forced to default on their debt, or the deflation will cause governments to attempt to wildly inflate assets in an attempt to not default on their debt, thereby causing paper money to become worthless. In both scenarios, worthless is the operative word. In our worst fears, where everything goes up in smoke in a one day crash of historic proportions, I always tell clients to make certain they have plenty of canned goods, bottled water, and a shotgun. Fortunately, our bearish foursome had perhaps more helpful ideas. In the deflationary scenario (Shiller, Rosenberg, Roubini) investors should overweight bonds in their portfolio. In the hyper-inflation scenario (Faber) investors should own hard assets and cash and diversify the custody of their assets around the world.
The most self-proclaimed bear of the group is Faber, and he offers up his asset allocation for investors who want to preserve wealth in such turbulent times. He recommends: equities: 20-30%, real estate: 20–30%, corporate bonds of different maturities: 20-30%, precious metals: 20-30%, and cash: 20-30%. If you squint your eyes a little bit, this allocation looks similar to Pinnacle’s portfolio asset allocations for conservative and moderate growth investors. We would take issue with the real estate allocation, and quibble with corporate versus higher quality debt, and even with the difference between short-term debt and cash, but the main idea is similar. Be diversified. Own a variety of asset classes. Stay away from leverage. Give yourself a short but reasonable time horizon to recover (three years or longer). I hope our most worried clients will note: None of these famously bearish commentators thought it necessary to load up on canned goods, bottled water, and shotguns as part of their asset allocation.
