STOCK WATCH


5 Big Risks to Your Portfolio Now

Despite the market's rebound and the recession's likely end, dangers still lurk for stocks.



The stock market seems to think everything is rosy. The nasty recession is quite likely over. Between the March 9 low and August 23, Standard & Poor's 500-stock index returned a remarkable 53%.

As gloom gives way to euphoria, it is worth leaning against the wind a bit and pondering some of the potential risks on the landscape. Here, we outline five of them.

Economy. No question, the economy is crawling out of an especially severe recession. But how vigorous and sustained will the recovery be? The market is assuming that a lot will go right.

Bob Doll, vice-chairman of money-manager BlackRock, thinks that lingering debt problems will cause economic growth to be less than half the norm coming out of a deep recession. The recovery, such as it is, owes much to government fiscal and monetary stimulus, the effects of which will likely fade next year. Goldman Sachs is projecting that economic growth will be 3% in the second half of 2009 but decline to just 1.5% for the second half of 2010. That doesn't sound too bullish for corporate earnings.

Consumer. It's hard to imagine a robust economy without a chirpy consumer. After all, consumers account for 70% of demand. But more Americans are in a frugal mode, paying down debts, increasing savings and repairing their busted household balance sheets.

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This will be a multiyear process. Merrill Lynch calculates that for households to return to the late 1990s debt levels (pre-credit bubble, but still elevated by historical standards), the extinguishment of $4.35 trillion of debt-more than 30% of the outstanding balance-will have to take place. A less leveraged, more frugal consumer will weigh on earnings.

Real estate. Yes, home sales have bottomed, and new-home construction will rise from its deep hole. But some things are still getting worse: More than one in eight homeowners with a mortgage were delinquent on the loan or in foreclosure at the end of June, a record level. Unemployment-related foreclosures on prime mortgages are rising sharply.

And let's not forget about commercial real estate, which entered a down cycle much later than residential real estate. The default rate for commercial mortgages is on a steep climb. There were simply too many shopping malls, office buildings and hotels constructed during the boom years. Banks, still trying to recover from the residential market collapse, will take another hit here.

Interest rates. You would expect rates to rise in an improving economy, but there's an additional factor at work this time: the frightening federal budget deficit. The Obama administration is forecasting a $1.84-trillion gap for the fiscal year that ends September 30, almost four times last year's deficit and equivalent to 13% of gross domestic product Investors, including foreigners, are likely to demand higher yields in the months ahead.

China. Bubblemeister Alan Greenspan was of the view that you can't identify a bubble until it's too late. Well, the former Fed chairman is entitled to his opinion, but Chinese authorities already seem to be worried about a bubble forming in their country's asset prices.

These prices have been inflated by easy credit and a massive government stimulus package to offset the collapse of export markets. The Shanghai market doubled from last November to early August, before retreating 20%. Share turnover on some days has been higher than that of the New York, Tokyo and London markets combined. The money supply is growing rapidly.

It is easy to imagine the Chinese authorities moving aggressively to deflate a bubble by curbing lending and jacking up interest rates before things get out of control. Global stock markets seem to move in sympathy these days, so the U.S. would not escape the impact.

No one knows for sure what the stock market will do in the future, especially over the short run. But with so much out there that could go wrong, this might not be a bad time to take some money off the table.




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