DEUTSCHE BANK: These Are The 10 Big Risks To The Economy In 2012

Simone Foxman 

 Dec. 5, 2011

 1:13 PM

Image: Meredit_Farmer via flickr

Analysts are doing a lot of worrying lately about all the bad things that could happen in the global economy, despite positive economic data and occasional market rallies.

Looking ahead to 2012, Deutsche Bank analysts Tom Joyce and Ram Nayak lay out 10 of the biggest worries investors have to look out for in the coming year in a massive investor note about what we should be looking forward to in the coming 12 months. What's more, they tell you how to hedge for the worst case scenario.

Ironically enough, analysts remains so bearish that one of the biggest risks is that the economy does well.

#1 A Greek exit rom the euro

Image: real democracy

Probability: A Greek euro exit and return to the Drachma is not DB's base case, but then again it's not inconceivable.
What would happen: Big haircuts on private sector assets, capital controls, collapse of Greek banking system, run on peripheral European banks
Hedges: Switch from European assets to gold or U.S. Treasuries, long yen or sterling, and long volatility indices

#2 Funding crises in Italy and Spain

Image: Alberto Pizzoli / AFP / Getty

What to watch: In Spain, the private sector and banking system. In Italy, politics and growth.
What would happen: A crisis of confidence would prohibit both countries from accessing cash and threaten both the euro and the global financial system.  The European Central Bank would need to "respond aggressively," to save the global economy from collapse.
Hedges: Short French and British banks, short Eastern European currencies, long options on CDX.IG

#3 The U.S. gets hit with a downgrade or double-dip recession

Image: bthomso via Flickr

Catalysts: Risks #1 or #2 materialize, fiscal cuts disappoint, or growth underperforms

What would happen: The U.S. bank sector could also be downgraded. Timing is everything to measure the impact.
Hedges: Issuers can win out by pre-funding, investors should be overweight on non-financials and highly rated non-cyclicals.

#4 A hard landing in China

Image: Daniel Goodman / Business Insider.com

How it happens: 5-6% growth, which would feel like a recession
What would happen: Global capital markets would be affected by sharp declines in commodity prices, but China's large Forex reserves it could probably stop the fall and stimulate growth.
Hedges: 6-month put option on commodities baskets

#5 France loses its AAA rating

Image: MJC Rodez on Flickr

Probability: "Quite possible," given lack of progress on austerity measures
What would happen: French-German bond spreads may indicate that this risk is already priced in, but this would have negative implications for the European Financial Stability Facility and already mounting funding pressures.
Hedges: Buy French CDS, "buy best-of-put options"—a put over the equity index that performs best on the period (because equity markets generally go down simultaneously with a macro shock)

#6 Aggressive and sustained deleveraging of European banks

Image: eyeSPIVE on Flickr

Probability: Deleveraging is definite. The only question is by how much.
What would happen: Deleveraging will probably total up to $2 trillion in 18 months, but this could be exacerbated by crisis.
Hedges: Investment in cyclical industries, lower-rated credits and financials, long volatility indices.

#7 Commodity trade finance faces a liquidity crunch

Probability: High, particularly if aggressive bank deleveraging (risk #6) materializes.
What would happen: The European banks that provide financing for the big Swiss-based commodity trading houses could cut funding, and commodities prices would fall.
Hedges: European borrowers should seek funding from the U.S., one-year USD puts on Brent

#8 Safe haven assets disappear

Signs for caution: Traditional safe-haven assets like gold, the Swiss franc, and the yen have all been volatile/
Worse still: U.S. Treasuries and bunds have been go-to investments recently, but high debt levels in the U.S. and Germany could change that.
Hedges: Other AAA-rated investments like supranational bonds and gilts.

#9 U.S. pension fund deficits continue to balloon

Image: Flickr Vertigogen

How it happens: Both public and private sector funding gaps for pensions are out of control, and this could get worse. Rock bottom interest rates are making this worse.
What would happen: Rating agency downgrades, declines in corporate profitability, and funding crises.
Hedges: Puts on equity indices where premium is only paid out when rates rise (the idea is that they don't).

#10 BETTER than expected economic growth

Image: Aepoc, CC.

How this is a problem: Betting against the market always carries the risk of being surprised.
What would happen: Europe stabilizes, the global economy grows, and risk asset prices exceed expectations.
Hedges: "10y/20y euro rates payer spreads; long non-conforming mezzanine debt; Short AUD v Long MXP"