Investors are advised to take precautions in 2012. The stage is set for the occurrence of extreme results for investors that go far beyond the normal levels of unpredictability, according to PIMCO’s Mohamed A. El-Erian (See “Investing in a ‘Fat Tail’ World”).
In the world of statistics, a normal outcome distribution resembles a bell-shaped curve with most of the outcomes or data points (e.g., the daily closing prices of a stock index) clustered within two or three standard deviations of the mean (i.e., the fat part of the bell) and the more extreme outcomes tapering off into ever skinnier tails on the left and right. In a seriously unsettled world, a spike in the number of results that fall outside of two or three standard deviations from the mean produces “fat tails” that mean increased risks for investors and the entire global system. That is the world that El-Erian and others see for 2012.
Fat tails occur when the global system loses its anchors, says El-Erian. The anchors are Europe and the United States. Europe is in danger of fragmenting. Ominously, Germany just issued the world’s first negative-yield debt offering. It was successful because of fearful investors’ willingness to pay Germany to hold their money. The U.S. is beset by high unemployment, zero interest rates and mounting deficits and debt concerns. On top of that, Iran is rattling its nuclear saber, North Korea’s is even more unstable after the death of Kim Jong Il, and the most important emerging economic power, China, is sputtering. In sum, there is a lot to worry about.
In such situations, people around the world seek to “self-insure,” says El-Erian, meaning they sit on record levels cash. At the same time, low interest rates, created by central banks, “are pushing investors out on the risk spectrum,” as they try to make their portfolios generate the returns they need to live. It appears to be a recipe for disaster.
As El-Erian concluded: “In such a world, prudence is the name of the game, and patience will likely be rewarded. To paraphrase Will Rogers, investors are well-advised to worry first about the return of their capital and second about the return on their capital.”
Page Perry is an Atlanta-based law firm with over 150 years collective experience protecting investor rights and fighting Wall Street greed.