The Fundamental Picture Is Changing & the Business Cycle Is About to Reverse

 The sovereign-debt issue in Europe represents the single greatest risk to global capital markets over the near term. It’s a serious issue that could have a cascading negative effect on investor confidence, which is always the most critical factor for financial markets.It seems like some headwinds are forming on the horizon, and they’re a culmination of multiple factors coming together around the same time. The sovereign-debt issue in Europe represents the single greatest risk to global capital markets over the near term. It’s a serious issue that could have a cascading negative effect on investor confidence, which is always the most critical factor for financial markets. The fact of the matter is that all Western countries have been living for too long off of the international debt market, and now that most of these economies are in a period of stagnant growth, there aren’t enough revenues to cover expenditures. It’s like the housing crisis just a couple of years ago—except this time, it’s on a country level.

The sovereign-debt issue is going to be around well into next year, and it is having an effect on investor confidence. On top of that, there is growing pressure for short-term interest rates to be increased in the U.S. Current interest rates are low enough that incremental percentage changes in rates shouldn’t materially affect the economy, but it’s clear that the cycle is about to change. This is another headwind for stocks.

So, my best guess is that these macroeconomic factors, combined with a recovering domestic economy, will basically lead us into a prolonged period of slow growth. Naturally, slow growth is better than negative growth, but the problem with non-robust GDP growth is that the rate of inflation can seriously erode your ability as an investor to generate positive returns from the economy. In the end, however, there’s nothing much that you can do about these fundamentals.

My worry with the sovereign-debt issue isn’t that European countries can’t address their fiscal problems over time, it’s that global investors will just decide that they don’t want to be in Europe for a while. Any big loss in investor confidence will have a seriously negative effect on currencies and will throw a major wrench into an already fragile economic recovery in the U.S. Whether you worry about it or not, currency volatility is destabilizing to just about all aspects of your life. This is why the sovereign-debt issue in Europe is so serious. We all know that investors have a bandwagon mentality. If institutional investors decide to jump the European ship, the risk to domestic equity investors will be severe.

The spot price of gold has been going up commensurate with fiscal worries in Europe. This is a good play, and one that I believe in. With U.S. economic growth slowing and the interest-rate cycle about to reverse, I think that investors have to play a good defense going forward. This is why large-cap, dividend-paying stocks have been outperforming recently. Institutional investors see the writing on the wall.