THE BLOG
05/20/2009 05:12 am ET | Updated May 25, 2011

Bad Time to Search for Paradise

You may or may not share George Soros' politics, but the billionaire global investor is dead on with his observation that it's either despair or euphoria on Wall Street. As of now, reflecting a spirited 25% market rally since early March and six straight weeks of rising stock prices, we're seeing a mini-outbreak of euphoria.

Soros himself ridicules the sudden, sharp outburst of happy economic talk, which ignited the recent rally. He, in fact, labels it a "bear market rally," given his contention the economy is still in a downturn and that the U.S. could fall prey to a depression.

Soros is not alone in questioning the legitimacy of the recent spurt in stock prices. Former Merrill Lynch strategist Bill Rhodes, now head of Boston-based institutional adviser Rhodes Analytics, also has doubts, telling me there remains much to be concerned about. Among other things, he sees several quarters ahead of deteriorating earnings and relatively weak revenues. Likewise, he notes the economy is still contracting, though maybe not as much as before. He also points out the credit markets still remain very stressed, which any would-be bank borrower could easily confirm. Other Rhodes' worries: the likelihood of higher interest rates and a probable move from deflation to inflation.

Some economic worry-warts think the stock market's most likely course is to turn flat and go sideways. Rhodes doubts it, saying that's probably the lowest probability. His expectation: "The market will roll over, with the Dow testing its recent March low of around 6500." Such a drop would represent about a 20% decline from the Dow's current level of about 8,100.

Meanwhile, repeated assurances and reassurances from one Wall Street pundit after another that the worst of the financial crisis is over and that it's time for the nation's more than 100 million stock owners to jump back into the market -- coming as they do in the face of lingering serious financial and economic risks -- remind me of a memorable film I saw many years ago, Lost Horizon. It was about a group of travelers who discovered a Utopian society, Shangri-La, a paradise in the Himalayan mountains. It would be a great place to live -- no health problems, no need for money, everyone is friendly and you have a life span of several hundred years. The only problem is that Shangri-La was never real, but the creation of a British author, James Hilton.

Equally unreal, some market watchers suggest, is a modern day recreation of an economic Shangri-La by Wall Street dreamers. One, crack investment adviser Michael Larson, sums it up in a recent market commentary in which he essentially belittles the growing beliefs that:

--The credit crisis is over.

--The real estate mess has been fixed,

--The economy is rebounding and the worst is behind us.

--The markets are headed to infinity and beyond and you better get on board.

Though not a nationally known investment celebrity, Larson, associate editor of Safe Money Report, a monthly newsletter out of Jupiter, Fla., is not a fella to be taken lightly. To his credit, he has been right on the money the past couple of years in alerting the letter's subscribers to an eventual bevy of economic, financial and market risks.

In effect, he rejects the notion that the skidding economy has hit bottom. Larson suggests investors are simply chasing a good deal of economic hokum pitched by Wall Street hucksters, who have been on a lengthy losing streak.

Indeed, many on Wall Street have basically been pitching happy economic talk since early last year. Towards the end of second half of 2008, however, many shoved back their timing for an economic rebound. No longer would it happen in 2008, but for sure in early 2009, they said. Well, we're in early 2009 and now the bullish brigade is signaling yet another extension. In brief, wait until the second half.

In arguing his negative economic case, Larson zeroed in on the ongoing and growing risks on several financial and economic fronts.

Kicking off with credit, he notes that the International Monetary Fund believes the U.S. has only acknowledged $1.29 trillion of the $4 trillion in total globe credit losses to date. That means, he says, we're not even a third of the way through the process.

Addressing housing, Larson observes that while we're seeing some tentative signs of life in several hard-hit markets, it's the distressed "fire sale" stuff that's really moving. Inventory levels remain high and foreclosures show no signs of abating, he points out. In fact, foreclosure filings hit a record high of 341,000 last month--a gain largely driven by rising unemployment and falling home prices.

Meanwhile, he notes, commercial real estate is going from bad to worse, with the business in full-scale meltdown mode, prices plunging, vacancies soaring and rents dropping. Indicative of the industry's bloodletting, last week saw a bankruptcy filing -- the biggest in real estate history -- by General Growth Properties, the nation's largest owner of shopping malls.

The backbone of the economy is consumer spending (about 70% of our GDP) and the latest news -- a 1.1% decline in March retail sales, a huge swing from an 0.3% gain in February -- is dismal. To Larson, it means the consumer is on the ropes and is in no mood to blow his paycheck at the mall. What's more, he says, this situation is unlikely to change anytime soon, not with jobless claims now running at more than 6 million -- the highest in U.S. history.

Adding to the economic woes, many factories are sitting idle, with industrial production in March dropping to 1.5%, the 14th decline in the past 15 months. At the same time, capacity utilization -- the amount of available space actually being used -- has fallen to 69.3%, the lowest level in 42 years.

What does it all mean? "At best," says Larson, "the economy will muddle along. Or at worst, it will slip even further down the rabbit hole, and stocks will ultimately head lower."

Dandordan@aol.com