Risk and volatility were the words most often heard and discussed by investors in 2011, and looking at the first month of 2012, it appears that this year will be as volatile and filled with risk as was 2011. Since the collapse of Lehman Bros. in 2008, market practitioners and academicians have been trying to understand what went wrong and how to protect us in the next financial crisis. Very important lessons have been learned, and many established theories and assumptions have been revisited and challenged.

One year ago, in the December 2010 issue of The Letter – Europe, we described the unraveling of the global financial bubble of 2001–2007 as follows: “2008 was the year of the Banking Collapse. 2009 was the year of the Great Recession. 2010 was the year of the Government-Sponsored Recovery. 2011 is likely to be the year of Facing Consequences.” And, boy, was that proved to be the case! We saw Greece declared effectively bankrupt in May; speculative attacks on euro zone banks in August; the fall of the Greek and Italian governments in November; a U.S.-dollar liquidity squeeze throughout the second half of the year; and we still don’t have a credible plan to rescue the euro zone from its fiscal crisis.

The global financial crisis of 2008 changed everything.  Almost overnight, investors moved from a world of apparent certainty and stability to a world of great uncertainty and potential instability. Few would now argue against the conventional wisdom that uncertainty is here to stay, for the foreseeable — or unforeseeable — future.