Everyone seems to be speculating on what will happen if the coming months resemble 2008, or something a little more mellow, but at this point, the question we should be asking- even if no one wants to- is this:

What if it’s worse?

There’s no easy answer to this question, and for two reasons. For one, comprehensive managed futures data is not extensive enough to reach back to, say, the Great Depression for insight. If this gets worse than 2008, we don’t have historical data to rely on. For two, we’re looking at a very unique economic scene.  Even if we could reach back to the Great Depression for comparison, the investment realm, nation and world were drastically different at that point. If we had to make an educated guess, we would say that managed futures would potentially benefit in the volatile times that followed some kind of major crash, but there’s no way to be sure (Disclaimer: Past performance is not necessarily indicative of future results).

Unfortunately, “What happens if things get worse than 2008?” is the question that literally everyone in finance is wrapping their minds around right now as they try to prepare for the coming storm. At this point, in our opinion, it’s not a matter of if things go bad so much as when and to what extent. Josh Brown of The Reformed Broker summarized it nicely here. The important part is this:

The veil between recovery and recession has never been thinner and all the old ghosts of the past have returned to haunt us once again, some of them almost exact replicas of their prior incarnations.  Witness:

Rumors of hedge funds blowing up run rampant through the tape.

Bankruptcy talk for storied franchises like American Airlines and Eastman Kodak now litters the headline ticker.

Confidence is at all-time lows.  We’ve not been this despondent about our leadership and forward-track in all of our recorded history as a society – the Civil War era and Great Depression included.

The certainty of higher taxes is also now taking hold, from the middle class on up.  We know it’s coming no matter who is elected, it’s only a matter of timing and degree.

And the banks – the banks that are still with us after the shotgun mergers of 2008 – they are haunted still by exposure to loans and homes values and other banks and leverage and all of the old bogeymen that once forced investors to rip money away for fear of utter dissolution.  Some of the most “systemic” banks in the market – Goldman ($GS), Citi ($C), Morgan Stanley ($MS), Bank of America ($BAC) – are once again trading at or below their crisis-level lows from 2009.  This after trillions in interest-free money and a two-year period of do-whatever-you-need-to-get-better.  Apparently they needed to get even more too-big and pay even heftier bonuses than ever before, not reduce risk or open up their balance sheets for serious scrutiny.  They’re going to pay for it now, flip on your quote screen.

But those are the devils we know…keep in mind that we have new ghosts this time around, perhaps even scarier ones to contend with in the coming months.

Brown goes on to explain what he thinks those unseen spectres might be, but what they are is not as important as the risk they present. Any major wrench in the gears would be kicking the global economy when its down… and possibly kicking us right off a cliff. Even with yesterday’s rally and a cautiously positive start to today, there’s a chance we’ve yet to see the worst of this.

We’re not trying to scare you or take the “Dr. Doom” moniker away from Nouriel. This is about preparing for the worst. Just as we urge our managed futures clients to expect the drawdown and anticipate it being worse than ever before, now may be the time for the average investor to expect the economy to head into drawdown in a movement more severe than we have the perspective to really comprehend.

What are the chances that the worst is yet to come? Even in a world where they’re small, they are definitely greater than zero, and that possibility is what investors need to protect themselves against. You prepare for the worst and hope for the best. Managed futures are not for everyone, but if it’s right for you, you may want to consider allocating to an asset class that has proven its ability (though there are no guarantees for the future) to perform during a crisis in our modern economic climate.

Don’t wait for $BAC to become a penny stock. The time to diversify is now- not after it all blows up.