January 25, 2010 Update: There are Significant Risks on the Horizon

As we begin a new week in the global economic and financial markets, we should be aware that there are a multitude of issues, concerns and outright problems that could create some very difficult economic and financial circumstances for all of us in the near term.

Here is a brief overview of some of the dynamics that you should really give some serious consideration to as they relate to your financial and economic well-being over the next few months and years:

Economics:

• The continuing weakness in the U.S. job market is beginning to signal the real possibility that the economy will likely grow at a much more subdued level than we all have grown accustomed to over the last few years. Moreover, a renewed decline in real GDP is a distinct possibility. If any concrete evidence that the U.S. economy is slowing emerges in near term economic reports, the global equity markets will react very negatively.

• The risks of some country (possibly Greece, Spain, Italy or Portugal) defaulting on its debt is becoming increasingly likely unless dramatic measures are taken soon. Any sovereign debt defaults will likely raise concerns about a domino effect that will cause other countries to default as well.

• The risks of some state (e.g., California, Michigan or New York and potentially others) technically defaulting on its debt is now a real possibility. Any default by a state would be very damaging to markets and market confidence.

Click here to see Bloomberg TV's "Is California The Nation's First Failed State?"

• There is growing concern that the growth that we have seen so far in the U.S. economy is due primarily to monetary and fiscal stimulus programs. There is concern that once this stimulus is removed, the economy will not be able to grow on its own. The Federal Reserve has stated that it will remove its monetary stimulus from the mortgage market in March, 2010. This could cause mortgage rates to rise.

Markets:

• Some stock markets around the world have already entered a corrective phase (e.g., China, Brazil, Greece, Spain, etc.). Given the global connectedness of markets around the world, there is a good chance that this correction could spread globally.

• The U.S. stock markets are starting to show technical signs of distribution (i.e., more selling than buying). This would suggest that some degree of a correction is beginning in the U.S. stock market. Given the many challenges facing the global economy and financial markets, a correction in the U.S. stock market could be severe if it materializes.

• From a relative performance standpoint, growth stocks are underperforming value stocks. This is the market’s way of signaling that there is concern about growth in the economy.

• Moreover, the S&P 500 industry sectors that should be leading the market, if we are truly in an economic expansion, are starting to under-perform those industry sectors that typically lead the market during an economic contraction.

Money:

• Despite the myriad of monetary stimulus programs that the Federal Reserve has instituted over the last couple of years, credit availability for businesses is still limited. Credit is vital to the growth of the U.S. economy, and without it, growth will not be significant.

• The voices of concern about the federal budget deficit are growing on a daily basis, as they should. The Obama administration recognizes this and is beginning to focus on the deficit. Unfortunately, this problem is so large and the potential solutions are limited. Nonetheless, it is potentially the most significant problem facing the U.S. over the longer term. Despite what we will be told by the powers-that-be, income taxes will be rising for all of us eventually. There is simply no way to avoid this.

Click here to see just how bad the deficit is: "Ten Trillion And Counting"

Charts of Interest

The following chart shows the YTD performance of the different industry sectors in the S&P 500 Index. The healthcare sector is leading and this should not be the case when the economy is expanding. The healthcare sector is a sector that money flows to in times of distress:

The chart below shows the year-over-year percentage change in the amount of commercial and industrial loans provided by commercial banks. The trend has been down since the beginning of the recession, but shows faint signs of bottoming out:

The chart below shows the U.S. unemployment rate and the number of claims for unemployment insurance as of December, 2009. Many experts question whether the unemployment rate that is published is actually reflective of the real unemployment situation. Most importantly, the official unemployment rate excludes so-called "discouraged workers" from the calculation. It is believed that the unemployment rate would be at least 0.5% higher if these individuals were included in the calculation:

The chart below shows an ETF that mirrors the performance of the China stock market. It is showing real technical signs that a correction in that market is underway:

Stay tuned.........................

Where Will The Jobs Be In The Next Decade?

How you manage your human capital is arguably more important than how you manage your financial capital. One way to enhance your chances for success in managing your human capital is knowing where it can be employed in the years to come.

The Bureau of Labor Statistics has published an interesting report detailing which occupations will see the highest growth in jobs over the next decade. Is your human capital positioned properly consistent with where the jobs will be in the next decade?

Click image for larger view

http://www.npr.org/templates/story/story.php?storyId=121875404

We All Need To Understand China Better: Our Financial Futures Depend On It!

This month, I have added two new books as my Books Of The Month. Both books are focused on China and the economic and financial dynamics that are shaping its rise to global economic leadership in the 21st century.

Virtually all influential scholars, economists and financial market observers acknowledge that China will play a major role in the future of global economics and finance. However, the implications of China's role in the future for the United States depends on not only China's actions, but our reactions to their actions.

Regardless of how the future dynamics actually play out, it is virtually a given that those dynamics will have a profound effect on the economic and financial well-being of the United States and its citizens.

So, we all need to understand China better because our future depends on it.

Here are some key insights from the two Books Of The Month on China:

SuperFusion - Introduction

"This is a book about how two countries became one economy. It is about how the fusion of the two most powerful economies in the world today is upending conventional wisdom and reshaping the global system. In the wake of the financial crisis that erupted in 2008, the fusion of China and the United States has become even more vital to the prosperity not just of hundreds of millions of Americans and more than a billion Chinese but for everyone everywhere. As the world emerges from the crisis and turns to the future, how China and the United States manage their relationship will determine whether the coming decades hold increased global prosperity or fractious, unstable growth with sharp divides between winners and losers."

When China Rules The World - Reader Comment:

As Martin Jacques argues effectively in this book, the West has misjudged China because of a bedrock assumption that modern financial and political systems have to follow some basic principles of openness, rule of law and democracy. That is the paradigm that favored the United States, and paved the way for its world domination, from 1945 onward. But China's remarkable progress is not following the script, and is challenging Western assumptions.

With clear and compelling writing, Jacques makes the case that when China is the dominant power, it will make the rules. It may even create a new international paradigm, one that is just as hard for Americans to foresee as it was for the British a century ago to foresee their own decline, and as it was for the Romans, long before that.

"The West has, for the most part, become imprisoned within its own assumptions," Jacques writes. "Progress is invariably defined in terms of degrees of Westernization, with the consequence that the West must always occupy the summit of human development."

I have started a specific section on this blog titled, "Understanding China". Here are some links to articles and videos that will help you to understand China better:

How China and America Became One Economy: What It Means to Global Prosperity
Financial Times - China
The Coming Economic Crisis In China
China's Around-the-Clock Auto Factories Still Can't Meet Demand
The 2010 Global Risks Report
Young and Restless In China
ChinaStakes.com
China Consumer Spending Power
Google Tried To Get Support After China Cyber Attack
Unleashing The Chinese Consumer

Stay tuned..................

California Unemployment Rates By County - November 2009

As of November 2009, the unemployment rate in California was 2.3% above the national unemployment rate:

Imperial and Colusa counties have the highest unemployment rates in California at 29.2% and 22.6%, respectively.

Click here for list of unemployment rates by California county

California's unemployment rate started rising before the national average at the beginning of the recession in late 2007, so one should expect it to start falling in advance of the national average when the job market does finally start to recover. So far, that is not the case.

Stay tuned............

World Economic Forum Sees > 20% Chance Of Another Financial Crisis

The World Economic Forum just released its Global Risks 2010 annual report, and it concludes that there is a greater than 20% chance of another asset price collapse occuring in global financial markets in the near term.

The six major global risks that it outlines in its report are as follows:

Risk #1: Asset Price Collapse:

The fact that the risk of an asset price collapse remains the strongest risk on the global landscape illustrates the continuing uncertainty about the resilience of the global economy and the effectiveness of fiscal and monetary responses, governance and regulation.

Risk #2: China Growth Falling to 6% or Less:

A loss in China's growth momentum could adversely affect global capital and commodity markets. The implications of a fall in China's growth would be particularly acute for its trading partners if it should happen before the global economy is on a more resilient path.

Risk #3: Fiscal Crises:

In response to the financial crisis, many countries are at risk of overextending unsustainable levels of debt, which, in turn, will exert strong upwards pressure on real interest rates. In the final instance, unsustainable debt levels could lead to full-fledged sovereign debt crises.

Risk #4: Underinvestment in Infrastructure:

Multiple studies across the world repeatedly highlighted that vast segments of our water, energy and transport infrastructure are structurally deficient or functionally obsolete, requiring considerable annual investments to avoid catastrophic failure.

Risk #5: Chronic Diseases:

As a consequence of profound socio-demographical transitions among large sections of the world population, changing physical and dietary habits, chronic diseases including cancer, diabetes, cardiovascular and chronic respiratory disease are continuing to spread rapidly throughout the developed and developing world, driving health costs while reducing productivity and economic growth.

Risk #6: Afghanistan:

The instability in the region is already a source of suffering for the local population. Their plight is compounded by the stress that rapid population growth and impact of climate change are placing on resources, in particular water.

The World Bank has warned that population growth is already causing water stress and could soon result in outright scarcity. The social and economic consequences of this should be as much a focus for the international community as the geopolitical implications.

Stay tuned.........................

S&P 500 Industry Sector Performance Update - January 15, 2010

While one week is not a definitive guide to market direction, it is noteworthy that this past week saw a rotation away from those industry sectors that typically lead during economic expansions:

The Five Day S&P 500 Index Industry Sector Performance:

Is the market trying to tell us that the economic expansion is losing steam? In order for the market to go higher, it needs solid leadership and one would expect that leadership to come from the technology, materials, industrials and financial industry sectors at this point in time if the economic expansion is on track.

Last week's poor relative performance in these industry sectors is worthy of monitoring to see if it is a trend that continues. If it does continue, the market is telling us something that we ignore at our own peril. Stay tuned.............

The YTD S&P 500 Index Industry Sector Performance:

The China Stock Market Update: Correction Beginning?

The recent technical action in the FXI (FTSE/Xinhua China 25) ETF suggests that a downward correction in the China equity market may have begun:

Given that the rebound in the China market started approximately the same time that rebounds began in other global markets (including the U.S.), this could be a prelude to broader corrections encompassing other markets around the world. Stay tuned..................

Why The "New Normal" Should Matter To You

Among the multitude of voices, commentaries and other so-called expert perspectives on economics, markets and money, there is one that I admire and respect for his vision and practical perspective. His name is Bill Gross and he is a renowned investment manager for the Pacific Investment Management Company (PIMCO).

In his November, 2009 Investment Outlook, Bill introduced his concept of a “New Normal” paradigm for the global economy and financial markets. He defines his “New Normal” paradigm as:

“A period of time in which economies grow very slowly as opposed to growing like weeds; where government plays a significant role in terms of deficits, regulation and control of the economy; where the consumer stops shopping until he drops and starts saving to the grave”.

More specifically, this new paradigm suggests that:

• The American-style capitalism that emphasized the making of paper instead of things is over and will cede global economic leadership to countries that actually make things. The United States must return to an economy that is geared towards making real products if it is to be a significant player on the global economic scene in the years to come.

• The invisible hand of free enterprise driven by the private sector will be increasingly replaced by the more visible fist of the government’s direction of economic activity in the United States.

• Global economic leadership in the 21st century likely belongs to Asia (particularly China) and Asia-connected economies (like Brazil and India).

• United States housing ownership levels will sink over time, and housing will not be a significant economic driver in the years to come.

• Unemployment in the United States is likely to remain high for many years to come. The “New Normal” level of unemployment will be much higher than it has been over the last few decades. Some jobs will never come back.

While there are no guarantees that Bill Gross’ vision will play out as he suggests, he makes a very strong case that is based on solid analysis and it should not be ignored. We should all acknowledge it; be on the lookout for indications of its validity; and be prepared to tactically adjust our financial and professional lives in response to it.

We should all get ready for the “New Normal”.

We Need Another Bubble!

I think we will all agree that the rollercoaster economic ride of the last decade has been very unsettling and financially destructive for many people in this country. Conventional wisdom suggests that we need to find a way to put our economy on a more stable upward trajectory that doesn't alternate regularly between boom and bust cycles.

But, is this really possible?

In other words, is it realistic to expect that, given the basic structure of our economy, we can ever get to a point where we have both significant and stable economic growth? I am increasingly becoming convinced that we cannot and we likely will not achieve this happy medium any time soon.

Unless we change the basic nature of our economy, significant and stable economic growth is not in our future. We can have significant growth, but it will not be stable. On the otherhand, we could settle for stable growth, but it will not be significant.

Here's my logic:

Since we have primarily a consumption-based economy (i.e., 70% of our GDP is based on personal consumption), we periodically need some new catalyst to keep the consumption engine firing on all cylinders. In other words, we continually need to give people a reason and the financial ability to consume more than just necessities in order for our economy to grow significantly.

In the 1990's, we did this with the tech bubble. As a result of hefty stock gains during that period, people felt wealthy and they ramped up their discretionary consumption as a result. The consumption cylinders were firing.

In the 2000's, we did it with the real estate bubble. Again, people felt wealthy as a result of the hefty gains in the values of their homes. Again, the consumption cylinders were firing.

Now, generally speaking, people feel poorer than they have felt in years. So, frivilous consumption has fallen and saving has increased. The consumption cylinders are sputtering.

Is this a good thing?

On a very basic human level, I think this change in financial attitudes is good. However, on a macroeconomic level, this means that our economic engine will not be firing on all consumption cylinders again for a long time. So, as long as we remain a consumption-based economy, this will not be a good thing.

I suspect that at some time in the not-so-distant future we will be longing for another bubble.

Stay tuned..................

YTD Performance By S&P 500 Industry Sectors - January 8, 2010

Based on the year-to-date performance by the S&P 500 Index's industry sectors, market participants still believe that the economy is in the early stages of an economic recovery:

The industry sectors that are supposed to lead in the early expansion phase of the macroeconomic cycle are financials, materials and industrials, and they are leading.

However, we should keep an eye on the consumer discretionary and technology industry sectors to see if they continue to relinquish their leadership from 2009. They too should be leading at the beginning to the midpoint of an economic expansion phase.

Stay tuned........................

My Fellow Californians: Things Could Get Real Ugly From Here.............

My fellow Californians, you may or may not have read about the latest state budget proposal from the "Governator", but I can assure you that you will likely feel the effects of his financial proposals in the months and years to come.

Regardless of how the inevitable budget battle plays out, things are likely to get real ugly here in the Golden State over the next few years.

Click here for a quick overview of the major proposals in the "Governator's" 2010-2011 California State Budget.

Now, I will be the first to agree that government spending on any level in this country is to some degree wasteful and inefficient. Moreover, our country needs to look critically at how we spend taxpayer dollars at both the federal and state levels because we simply cannot continue on the path that we are on with deficits at all levels of government.

However, unless we believe that all government spending on programs to provide a financial safety net for deserving citizens is wasteful, then cuts in many of these programs will be catastrophic for many of these  recipients directly and harmful in some way to all of us indirectly.

Here are some potential social impacts related to the proposed cuts:

- Cut the CalWorks program, the state's primary welfare-to-work program. So, do we expect that these recipients will just quietly go away or find some other financial support vehicle, given the current state of the economy? I wouldn't bet on it.

- Cut the prison budget by shifting nonviolent prisoners to county jails. I hope they choose the right prisoners to shift to these less secure facilities. I guess it must be better to have overcrowded county jails rather than overcrowded prisons.

- Raising more revenue by catching more speeders and red light violators. I don't know about you, but I started noticing a more visible presence by CHP about six months ago. Now, I understand why. The state has decided that it will help close its revenue gap by pulling over more drivers for speeding and whatever else they can make stick. Cities are getting in on the act as well by being more aggressive with parking fines.

- Reducing the juvenile prison population and closing the facilities that house them. With serious juvenile crime on the rise coupled with above-average unemployment amongst juveniles, I suspect we will be needing more juvenile prison facilities, not less.

Lastly, the "Governator's" budget is built on a very questionable premise that the federal government is going to give California some $6.9 billion that the "Governator" says the state is "owed". If this money doesn't materialize, the budget cuts will get more draconian.


See what others have to say about the state of California's finances and its proposed budget for 2010-2011:

"Invitation to Disaster"
"California: Is Default Inevitable?"
"California Budget To Raise Millions From Red Light Cameras"
"What Happens When California Defaults?"

Stay tuned........................

Which ETFs (Exchange Traded Funds) Will Lead In 2010?

In 2010, all eyes will be on the Federal Reserve Board and the various economic indicators charting the health of the U.S. economy. There will be winners and there will be losers.

Will the Fed achieve a delicate balancing act with its monetary policy?

Will the economy maintain its positive momentum after the Fed and the government start curtailing their various stimulus programs?

Will the ETF leaders from 2009 continue their run in 2010?

Will the ETF laggards from 2009 play catchup in 2010?

Click here to see how all the major ETFs fared in 2009.

We will be paying very close attention to the global economic and financial dynamics to determine the answers to these questions as soon as they become apparent. Stay tuned..........

Could You Have Seen The Great Recession of 2007 Coming?-----YES!

In my conversations with people about the recent economic and financial turmoil that we have experienced over the last couple of years, I get the impression that most people think that these kinds of distressful events just happen with no warning. That is simply not the case.

While noone has a completely accurate crystal ball that tells them when the economy is going to enter a boom or bust cycle, there are clearly observable relationships that exist in our economy that can telegraph the increasing likelihood of an impending boom or bust cycle. Such was the case with our most recent economic upheaval, dubbed the The Great Recession of 2007:

Click Here To See How

With a little better understanding of economic relationships, you can enhance your chances of taking advantage of financial opportunities and avoiding financial risks. You can be sure that the U.S. economy will experience other booms and busts in the future. Will you see them coming next time?