Here’s What a Full Blown European Debt Crisis Could Look Like

This morning investment analysts at Deutsche Bank (NYSE:DB) released a report detailing a “worst-case scenario” for the outcome of current debt crises in Europe. The report finds that “a continuation of this trend is the primary risk that could see world stocks (the MSCI World index) lose up to 35% of their value if the situation deteriorates into a full-blown financial crisis on the scale of the fallout from the collapse of Lehman Brothers in 2008.” Uh-oh.

The authors continue, “While consensus is that equities are not overvalued at current levels, we believe that investors and politicians underestimate the impact that a full-blown financial crisis would have…On a milder scenario, under which the crisis is contained and does not spill over to the real economy, we would still expect the MSCI World (MXWO) to fall by around 12 percent…Prompt action from European authorities could avert this worst-case outcome, however. But the downside risks to our relatively mild scenario have undoubtedly increased recently.”

Already heading in that direction, the MSCI World Index has shed 2.5% so far this week. Barring a rally by closing time today, that would make for the index’s worst performing 5 day period since August of 2010. The analysts end their report by offering some tidbits on how investors can protect themselves from exposure to the potential economic catastrophe. 1) “Buy protection on European sovereign/bank/insurer CDS with exposure to systemic risk but which are currently cheap vis-à-vis this exposure.” 2) For equities, “Buy a liquid put for crash protection.” 3) Re: rates, “Buy puts at the short end of the curve to hedge liquidity risks.” 4) Look to buy stock in companies with healthy balance sheets, high cash reserves and low debt.