3 Cassandras Bare Ticking Time Bombs

Fed up with all the bad news? Me, too. But as the Boy Scouts tell us, be prepared. Makes sense to me, especially if it relates to what worries an awful lot of folks -- namely potential new risks on the economic and financial fronts.

In this context, I thought I'd pass on what I've heard from a trio of incisive and dogged trackers of the economic and investment scene. In recent days, each has conjured up a scary scenario that could create a lot more economic mayhem, in turn igniting new waves of downward pressure on an increasingly shaky stock market. Call them ticking time bombs waiting to explode, worrisome new threats that are largely being ignored and which not conspicuous on the radar screen.

In effect, our trackers challenge the party line from Washington and Wall Street that the worst of the economic crisis is definitely behind us and they call attention to what they see as distinct economic dangers.

What makes it especially worrisome is that a fair number of impressionable investors, for now at least, seem to be smitten with the idea that a solid economic rebound is on the way this fall that will rekindle the recent faltering 40% rally in the S&P 500.

What's more, they're backing up this view via a cash flight back into the stock market big time. Like fish captivated by dangling bait, these investors, though in the minority, have suddenly become much more risk prone. In the past five-and-a-half weeks, a for example, in a period of growing market fatigue, they've snapped up a shade under $10 billion worth of U.S. equity mutual funds, according to West Coast liquidity tracker TrimTabs Research. In other words, greed, despite the obvious danger, is beginning to creep back into the marketplace.

Not everyone, though, is comfortable with this renewed enthusiasm for stocks. Indicative of this, many wary investors -- setting temptation aside -- have paid little heed to the stock market rally. Over the past three months -- reflecting a fear of equities and a ravenous appetite for higher yield than the puny payouts offered by money market funds of well under 1% -- they've gone on a fixed-income buying spree, gobbling up about $30 billion a month in U.S. bond-oriented mutual funds.

Now to those scary scenarios, kicking off with J.C. Spender, an economics professor at Britain's Open University School of Business in Milton Keynes and a noted academic, who opts for a more cautious strategy. "Things could get very nasty," he says. "For two decades, the U.S. has had a consumer-driven economy. No more. Consumers are now on the ropes and they should remain there for several years, given the high rate of unemployment. So where will the recovery come from?" His view: For now, it's invisible.

Describing himself as a prisoner of collective pessimism and pointing to the disappearance of many jobs, the incredible amount of lost production and consumption and a staggering loss of construction, Spender fears unemployment could get progressively worse. "The numbers could be horrifying," he says. "We could see figures that we haven't seen since the Great Depression era of the 1930s." During that era, the jobless rate peaked at 25%, nearly three-fold the current 9.5% rate.

"Right now, things look awfully blue," Spender says. "I'm excited about the green shoots, but I don't see them. We're all hoping things will get better and that the worst is behind us. At the moment, though, that's solely hope and belief and there's nothing that bears it out."

Spender also took a swipe at the Republicans, who, he argues, are "seeking to crush the economy and then say I told you so. They claim they're being patriotic, but they're currently displaying a deplorable lack of it."

A big Wall Street debate centers on those who worry about inflation and others who fear deflation. One well regarded investment mind, Bill Rhodes, the skipper of Boston-based Rhodes Analytics, which doles out market advice to institutional investors, points to another ticking bomb -- an outbreak of stagflation (a combination of declining or no economic growth and rising prices) which he expects will rear its head in the next two to three months.

In particular, he sees rising import prices (a reflection of a weakening greenback) creating additional economic stress for the lower income group, the people who are the chief buyers of such goods and who can least cope with these price hikes. Rising imports, he points out, also means the jobs of the people in this income bracket will become more precarious and their ability to buy such goods will be substantially reduced, leading to spending cutbacks. His bottom line: a declining number of economic transactions, an unusual event in U.S. history, which will worsen the economic downturn.

"If prices go up for imported goods and lower for domestic goods, we could begin to import inflation after exporting it for a very long time," Rhodes observes.

About two months ago, Rhodes, citing a huge amount of liquidity on the sidelines, was bullish on the market. No more. Now, he believes, we're in a bear market rally. One major problem, as he sees it: The credit markets will take longer than expected to recover, which means the economic recovery will be prolonged and the equity market will be damaged. Further, it's harder to fix credit market problems in a bearish market environment.

Based on the latest economic data, Rhodes says "I suspect we're in for a selloff and we could test the March lows (6,547 in the Dow Industrials)." Such a test would send the Dow skidding about 24% from its current level of around 8,145.

Jeannette Schwarz, editor of the Option Queen newsletter and a member of COMEX (the Commodities Exchange), focuses on our third ticking bomb, which she regards as the biggest market risk. That's the declaration by the Asian countries that no one currency (notably the U.S dollar) should be the reserve currency. "If we lose our status as the reserve currency, the dollar, which supports our ballooning national debt, would lose value, thus setting the stage for a new inflationary spiral. And the market, in response, would suffer a great deal of pain."

At present, our national debt stands at $11.4 trillion. Or an average debt per person of $37,320.

What about Uncle Sam's efforts, including the $787 billion stimulus package, to resolve our financial mess? "The government is acting irresponsibly," Schwarz says; "they're trying to put a Band-aid on an arterial bleed."

Comments

[jason77]

Commercial real estate is a further disaster mechanism. No consumers, no filling the stores, so the huge overcapacity in production (hence unemployment) gets transformed into huge overcapacity in distribution (hence collapsing commercial real estate values and subsequent bond and loan defaults).

Right now commercial real estate owners, realizing they cannot sell, are being forced to let to those who cannot get financing to purchase - and who want to find a way of profiting from the owners' pain by putting in place low-rent deal that will protect them for 3 - 5 years.

Deals in the NorthEast at $8 per sq ft by people who could have let at $12 a couple of months ago and who actually anticipated $17 per sq ft before the economy tanked.

It is going take years for all this to recalibrate around a completely re-structured economy. This is not a matter of 'going back' to the Happy Times.

[flamenfiddle]

What about commercial real estate? Who's propping that up?

[Hailmaryyy]

Forget stagflation. The economy is experiencing deflation. It will continue to experience global deflation. This is the by far the biggest risk we face.

There is nothing to replace the dollar as the world's reserve currency, nothing. Forget that too.

As for unemployment rising to 15% to 20%, that is a real risk and I worry greatly about that.

http://www.escapethenewgreatdepression.com

[confidance government]

"There is nothing to replace the dollar as the world's reserve currency, nothing. Forget that too."

Why would governments be interested in changing the backing of their currency from one set of fancy colored paper to another? However, the central banks of the world may see the benefit in slowly and discretely selling of our company script in exchange for items of real value such as commodities, manufactured goods, etc.

As for deflation, I don't see how greatly expanding the monetary base, inflation, is not going to eventually manifest itself as price inflation once velocity increases (which granted may be a decade away)

[jhNY]

And that's why Obama was so smart to shovel all that money to the wizards of finance from the US Treasury, and why he is undoubtedly correct when he says no second stimilus will be necessary.

[Indra]

Yeah, well you do not have to be an economist to know that we are in a depression. I wonder how long it will be before they use that word. It took them a year before they admitted we were in a recession.

[ErnestineBass]

Good article, Mr. Dorfman.

Too bad no one listened to the Cassandras of two or three years ago.

[RoloTomassi]

I suspect we're in for a very long haul with all of this mess; I read a Krugman post this morning where he states that is growing worry is deflation....

The only truth right now, I fear, is that no one really knows what will happen next, but that it will be bad, regardless....