I’m generally a positive guy, the type of person who always sees the glass as half full. These days though, I continue to wonder how the economy and the stock market could possibly do well in the next 5 to 10 years. Why? I guess the two main reasons are the state of the US economy with housing, credit, banks and other financial firms balance sheets that are questionable.

The much more important factor though is the continued weakness in Europe. I wrote about investing when your country is going bankrupt and while that is certainly a threat, I think a much closer one is the collapse of the European Union. It’s been very well documented that many small European countries such as Greece, Portugal, Ireland, etc. Then we found out about all of these Spanish banks that have worthless loans on their book, about other banks (French ones especially) that have not marked-to-market their European sovereign debt, overstating their true balance sheet.

Then Elections Come Up

The more recent story though is Europeans voting for new parties that are less favorable to austerity, to getting their finances under control, etc. Greece looks set to stop paying its debt holders, is considering leaving the EU. Even France, while still improbable, is considering drastic measures and renegotiating the financial stability pact that was signed months ago. Germany will not and should not accept to do so but it is still very worrying. If you had funds invested in the European markets or your own assets in a European bank, what would you do? I would probably take my money out and move it to a German or Swiss bank or overseas. The big problem is that millions are now in the process of doing just that creating a self-fulfilling failure.

Then yesterday, Spain decided to nationalize one of its bank and it will likely not be the last one…

The Big Problem Here

Both you, I and the markets in general do not like uncertainty. The problem is that no one knows how this will play out, there will likely be many more ups and downs in the next few years and I’m not sure where the economies and stock markets of all of these countries will end up. This creates major issues for those of us that invest in the markets.

What To Do?

–Inflation Protection: I think it’s very possible that many countries will continue running deficits and end up printing money which could create inflation issues around the world. Owning part of your portfolio in gold, TIPS and other good inflation hedges seems like a smart thing to do

–Avoid Timing The Market: In what will clearly be a very volatile world, there will be many ups and downs and many will tempted to time their investments and trades. That will prove to be incredibly challenging and if you are investing in a long term retirement account, I would try to by systematic rather than trying to buy at the lows and sell on the highs.

–Control Your Risk: Only invest what you feel like you can risk losing. It will never go down by 50% in a few days but it could take a 10-20% hit within days. That is fine if you are investing with a long term horizon and do not mind big fluctuations but if you do not fill those criteria, I’d go for a safer portfolio.

–No free lunch: If you see something that looks too good to be true, it usually is. High yield investments are very trendy these days but the added yield comes with a potential downside if things do go wrong. It’s important to remember that.