Industrialized world still shaky

The industrialized world faces a period of extreme volatility, at a time when its governments must engage in severe fiscal tightening, according to economists and strategists at the Morningstar Investment Conference.

“We went through the worst financial shock since the 1930s . . . the worst recession in the industrialized world since the second world war,” said Craig Alexander, senior vice-president and chief economist, TD Bank Financial Group. “When you go through an environment like that, you don’t come out the other side to smooth sailing.”

Investors should anticipate a “risk-filled” recovery, Alexander said. The greatest risks facing the world include a European debt default large enough to bring down one or more of the continent’s big banks. That possibility is far more likely than people realize, he says, rating the risk as a one-in-three chance.

Politicians looking to rein in social spending could face a massive backlash, as there is no grassroots support for propping up the banks.

Scott Colbourne, senior portfolio manager, Sprott Asset Management, said Greece will not be allowed to default on its debt until French and German banks have realigned their balance sheets, eliminating their exposure to riskier sovereign debts. After that, however, all bets could be off.

Greece’s debt restructuring is likely two or three years out, according to Patricia Croft, chief economist, RBC Global Asset Management, and the bigger threat is really Spain. A second credit crisis is already brewing on the Iberian Peninsula, she says, with smaller banks virtually locked out of the credit markets.

Meanwhile, there has already been a stampede into German government bonds, Croft says, as investors hedge against the possibility of a euro-zone collapse. If the euro were to disintegrate, German bonds would likely be repriced into deutschmarks, rather than euros.

If the euro is to be saved, however, it will come at the expense of the core countries of Europe, she said, in which case investors caught holding German and French sovereign debt will take a beating.