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Economic Forecasts

What Could Slay the Bull

With stocks up sharply from their bear-market bottoms, investors have regained their confidence. But a lot could still go wrong.

THE RISK: Greece's woes spread.WHY IT MATTERS: It's one thing for bond raters to downgrade Greece to junk status. But as they showed in early May, investors will grow increasingly concerned about a global slowdown if larger nations that carry more weight, such as Spain or Italy, get into a bind. A string of failures (or near-failures) in short order would have a profound impact on investor confidence.LIKELIHOOD: 25%

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THE RISK: Tech spending fizzles.WHY IT MATTERS: A bull market needs leadership, and the technology sector is providing it. First-quarter earnings at tech companies were up 74% from the year-earlier period, with stalwarts such as IBM and Intel reporting that customers are loosening their purse strings. If businesses cut tech spending later this year, the stocks will fizzle and drag down the rest of the market.LIKELIHOOD: 10%

THE RISK: Bank scares continue.WHY IT MATTERS: As we learned in 2008, solvency crises at huge financial firms scare the stock market far more than massive frauds at places such as Enron. It's no accident that stocks began to recover once investors concluded that the big banks would survive. But the government's lawsuit against Goldman Sachs is a reminder that problems at big banks can still frighten investors.LIKELIHOOD: 15%

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THE RISK: Jobs remain weak.WHY IT MATTERS: As a leading indicator, the stock market always moves ahead of the economy. But labor figures remain troubling, with unemployment still at nearly 10% (as of April) and new-job creation anemic. If job growth doesn't start improving soon, consumers are likely to retrench again, threatening corporate profits and causing investors' enthusiasm for stocks to fade.LIKELIEHOOD: 20%

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THE RISK: Interest rates soar.WHY IT MATTERS: With short-term rates at 0% and ten-year Treasuries yielding 3.5%, rates have nowhere to go but up. A bull market can handle an orderly uptrend in rates. But if rates zoom, stocks will struggle, as hikes in short-term rates by the Federal Reserve made clear in 1994 and 2005. Meanwhile, massive budget deficits will eventually lead to higher bond yields.LIKELIHOOD: 10%

THE RISK: Earnings disappoint.WHY IT MATTERS: U.S. firms are reporting stellar earnings so far in 2010. The bad news is that analysts are dramatically boosting forecasts for the rest of 2010 and 2011. As is often the case, they'll probably go overboard, increasing the likelihood that companies will have trouble meeting those expectations later this year. Stock investors will not take kindly to unpleasant surprises.LIKELIHOOD: 10%

THE RISK: China crashes.WHY IT MATTERS: In northern China, Ordos, a city built for one million people, lies empty, a symbol of the nation's real estate mania. Residential property sales totaled $560 billion last year, a rise of 80% from 2008, and prices are soaring. Prices will eventually reverse course, and the Chinese banks that have fueled the boom will be stuck with massive amounts of bad debt.LIKELIHOOD: 25%

THE RISK: Cities and states falter.WHY IT MATTERS: Public finances are not as sour as they were in 2009, but 48 states and hundreds of localities remain in the red. That's a concern not just for municipal-bond investors but for shareholders as well. To tackle deficits, governments are raising taxes and cutting services, reinforcing Main Street's doubts about the economy. That's bad for the recovery and for investor confidence.LIKELIHOOD: 10%

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