This week’s World Economic Forum heads to Davos Switzerland as it does every year. But what doesn’t get all the publicity is the excellent risk report that the Forum releases each year. This year’s report lists a number of economic risks highlighting the fact that black swans tend to arise out of much larger macro trends. For instance, understand the ripple effect of potential housing distortions led directly to the household debt crisis and ultimately the banking crisis. The Euro crisis arose out of chronic trade imbalances caused by the single currency system. So, understanding the macro trends and the macro risks can certainly aid in helping one understand potential problems down the line (and ultimately aid in avoiding huge portfolio potholes). This year’s report lists 10 macro trends that have the potential to result in black swans:
“The economic category addresses those risks that are of greatest concern in terms of likelihood and impact in areas covering a range of macroeconomic concerns, from financial systems and infrastructure to price volatility and regulation (see Figure 28 for the full list of economic risks). Being in the forefront of public debate in recent years, chronic fiscal imbalances and severe income disparity emerged this year as the two most likely economic risks to manifest in the coming 10 years. In addition, these two risks are rated as having potentially high impact, along with extreme energy and agriculture price volatility, as well as major systemic financial failure (see Figure 26).
Responses to this year’s survey identified chronic fiscal imbalances as the Centre of Gravity in the economic category (see Figure 27). Chronic fiscal imbalances shares important interconnections with risks from three categories, and it is most strongly associated with the economic risk of major systemic financial failure – a risk that captures the collapse of both major finance and banking institutions, as well as currency regimes. As the Centre of Gravity in the economic category, it follows that the topic of chronic fiscal imbalances is linked to all four Critical Connectors. It is also strongly associated with global governance failure, mismanagement of population ageing and several geopolitical and societal risks, which relate to the collapse of governments and international trade. Interestingly, all four Critical Connectors are economic in nature, which demonstrates that economic risks play a particularly significant role in defining the level of resilience or instability within the global risk system as a whole.”
The list in descending order from riskiest to least risky:
1. Chronic fiscal imbalances
2. Severe income disparity
3. Extreme volatility in energy and agriculture prices
4. Recurring liquidity crises
5. Major systemic ﬁnancial failure
6. Chronic labour market imbalances
7. Prolonged infrastructure neglect
8. Hard landing of an emerging economy
9. Unforeseen negative consequences of regulations
10. Unmanageable inﬂation or deﬂation
Read the full report here.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.