Let’s take a moment to dissect CM001’s post:
one of the investment banks in Europe could blow up.
…if it goes down it could cause …
So there could be some real shocks.
While most of the debt may be re-financed…
if they get refinanced at higher interest rate what they could do to the earnings…
The reason I am mentioning this is because there are risks out there and we may get lucky and they may not materialize but “nothing that should scare the pants off investors” is bit of a stretch.
As investors we would do well to distinguish between “uncertainty” and “risk proper.” I had a hard time getting my head around the idea of what risk really is. The best explanation I’ve found was from Frank Knight which I link below.
If we replace the word “risk” with “uncertainty,” CM001’s post is spot on! It becomes a generic problem of how to deal with uncertainty, the ones CM001 mentions and other we can’t even imagine. After all, the future is uncertain, no one can predict it.
If Deutsche Bank is risky the solution is simple, avoid it. I avoid all banking with credit risk. Or buy it only on the deepest discount. I believe that the best remedy for uncertainty is to have a sturdy portfolio which means debt free and no speculative positions no matter how enticing. Think back to the 2008 bust. If the stock market was not in a bubble, not overbought, as I contend, why did stock prices collapse? Leverage! The derivatives players used huge amounts of leverage to play the game. When the mortgages started to default, the securities backing the derivatives became worthless and the issuers got “margin calls” or other similar requests for additional backing. The most readily available liquid assets were equities which they sold driving down the price for reasons that had nothing to do with value but solely because supply exceeded demand. If your portfolio had no debt and no speculative positions, you could watch the butchery from the sidelines! Gladiators killing each other!
My response to CM001’s uncertainties (which are real enough) is a sturdy portfolio.
Risk, Uncertainty, and Profit
Knight, Frank H.
But Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The term “risk,” as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal relations to the phenomena of economic organization, are categorically different. The nature of this confusion will be dealt with at length in chapter VII, but the essence of it may be stated in a few words at this point. The essential fact is that “risk” means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is really present and operating. There are other ambiguities in the term “risk” as well, which will be pointed out; but this is the most important. It will appear that a measurable uncertainty, or “risk” proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We shall accordingly restrict the term “uncertainty” to cases of the non-quantitive type. It is this “true” uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of profit and accounts for the divergence between actual and theoretical competition. [Emphasis added]