Is now the time to rethink the basics?

In what is, by now, a viral video on the internet, a presentable ‘independent trader' Alessio Rastani speaks to the BBC about the unfolding economic crises. He presents an alarming, if not paints an apocalyptic, picture of the economy.

In that interview, he makes three key points: 1, the markets are about to collapse and yet, there are ways to make money in a downward market, 2, individuals and organisations must ‘protect' their assets using ‘hedging strategies,' 3, the world is not run by sovereign states, but by transnational institutions like Goldman Sachs, who have fiduciary responsibility to their shareholders solely. Perhaps most alarming to an average viewer, and the principal reason for the interview to spread is, Rastani's amoralistic preening that he's been waiting for a recession for the past two-three years.

Alas, for Rastani however, the Telegraph investigated his claims as an ‘independent trader' and discovered he had $2,000 (Dh7,346) in his account and $20,000 of negative equity after four years of trading. With charming candor, Rastani confessed: "I agreed to go on [TV] because I'm [an] attention seeker. But I meant every word I said."

Whatever one may think of Rastani's braggadocio, or the BBC's fact checking skills, his words echo the sentiment that many serious analysts have increasingly discussed. In some sense, by ‘unpacking' parts of what he said, we get a sense of what the principal issues of the small investor are.

No Great Depression

The first and foremost question is: is there a collapse likely? The answer, like in most economic matters, ‘depends'. If one is looking for large-scale bank defaults and closures that we saw during the Great Depression, the answer is clearly a no. Banks are much better capitalised and the larger economic system has withstood large unexpected shocks in the past three years. So, in some sense, ‘collapse' it will not be. Yet, that doesn't mean there isn't a downward draft.

Bill Gross, the bond manager, pithily wrote this week in his monthly investment letter: "Sovereign balance sheets resemble an overweight diabetic on the verge of a heart attack".

The overweight part of Gross's statement is that sovereign states across the world have piled on massive amounts of debt at all levels of government under various guises. Be it in the form of bailout packages, expansionary fiscal policies or simply borrowings to tide over interest payments.

At the sub-national level, municipalities across America continue to be hobbled by financial crises. Small towns such as Vallejo in California and large cities such as San Jose struggle to finance their debt.

Heart of the problem

To many analysts, large-scale unsustainable wage-deals with unions are the reason. To others, it is the State and Federal inability to tax the rich that is at the heart of all problems. Understandably, the truth lies in between. Unions wages and benefits have to be normalised, while corporate and personal tax rates for millionaires must rise. Unfortunately, a rapprochement is nigh impossible in the present climate.

So, what should we expect? This is where the ‘heart attack' part of Gross' statement comes to fore. In the United States, stagnant, if not rising, unemployment levels are a given. The impact is clear: households will go into a savings overdrive, lowering consumption levels which aggregate spending declines. As expected corporate profits will decline and the equity market will respond. A recession is seemingly inescapable. There are analysts who predict Standard & Poors will decline to around 450, from the current 1,100 levels. This may seem exceptionally pessimistic. Even a decline to the 650 levels is nearly a 40 per cent decline. Imagine losing your retirement savings by 40 per cent.

The lesson from this general pessimism is that those who hold equities in their retirement funds might be better off looking to get out of equity as an asset for the next three months to two years. This is a tough decision as many investors are locked in, will incur transaction costs and perhaps might even take a loss if they try to exit. But, the time to rethink hard is upon us. Where can one invest instead? Look for assets that trade in emerging markets, where growth is relatively expected to hold up. If equities are a must, look for assets like healthcare and other essentials to daily life.