First Mortgages, Now Sovereign Debt—a Cascading Currency Crisis Means the End of the Stock Market

economic newsThe economic news we keep getting continues to be mediocre, but with a slight positive bias. It’s my view that the U.S. economy is on a stronger footing than the stock market has priced right now. Stock market sentiment is being adversely affected by the political and sovereign debt uncertainty in Europe and this investment risk will continue to be with us going into 2013.

Large-cap, dividend paying stocks continue to be the most attractive in this kind of environment; although there’s no need for investors to jump into any new positions. Investment risk is that high, with most mature economies awash in sovereign debt. It’s a pickle for individuals with money to invest. Safe, short-term investments like cash or money market funds don’t pay interest rates that beat inflation. The bond market is at the end of its bull market and commodities don’t generate any income. So, other than real estate, the stock market is just about all there is for an individual investor who wants some income with the potential for capital gains.

Once again, I repeat my view that stock market investors need to be very conservative with their holdings. The U.S. economy could very well experience another recession next year and the Federal Reserve is just about out of tools to inflate the Main Street economy artificially. This is why I’m advocating a strong, risk-averse investment stance for those looking at stocks. Frankly, the global economy could easily go into total turmoil if Greece’s sovereign debt problems cascade into Spain and Italy. And currency turmoil is the absolute worst kind of crisis you can have. Everything gets distorted when there’s currency instability. Just look at the spot price of gold—gold and silver prices should be higher, but they’re not, because of a stronger U.S. dollar due to problems in the eurozone. (See Just to Interject—the Debt Bomb Is Still Ticking.)

The single greatest risk to your stock market investments is the sovereign debt crisis in Europe. It’s unfortunate that many Western countries just can’t seem to manage their books properly; but, at the end of the day, who is going to vote for more taxes and less services? Just like the subprime mortgage meltdown, the sovereign debt crisis in Europe is likely to cause some serious havoc with your stock market portfolio over the next several years. That’s why, if you’re long the stock market, you’ve got to be conservative with the vast majority of your holdings.

The real problem with the sovereign debt crisis in Europe is that the top European banks (I’m not referring to central banks) own most of the debt. This means that the entire European banking sector is at risk of collapse. We almost lost Wall Street after the subprime mortgage crisis (some may view that as not being a bad thing) and now we’re at risk of losing European capital markets due to sovereign debt.

As an individual investor in this kind of environment, I’d keep my investments at home and conservative. The risks to the stock market outweigh the potential returns and that’s why blue-chip, dividend paying stocks are the only game in town as far as I’m concerned. The U.S. economy is in a slow recovery, but it’s not unrealistic to expect the sovereign debt crisis in Europe to knock the whole thing underwater.