At about this time of year, most Wall Street firms are releasing their economic outlook for 2006 and beyond and doing the usual mea culpa for missed targets. At any given time you'll find pros and cons for what the future holds for the economy, and by inference, for the domestic and global investment markets. Hence, any assessment worth a grain of salt will focus on not just the general predictions of GDP, inflation and so forth, but also on the possible downside risks to that prediction.
Rather than address one analyst or another and nitpick their prognostications, I thought a more valuable contribution would be to point out that few analysts are taking what I would call a sober look at the potential risks we face today. Moreover, those who are covering some of the concerns are not doing so as comprehensively as they might. Perhaps they don't want to appear as gloom and doomers, but just the same, being from the same industry I often find that the tendency is to downplay risks in order to encourage participation. In other words, more than a few year-end bonuses depend on your confidence pushing the market up as high as possible.
That said, here is my list of situations you should be soberly monitoring, even if some "experts" might suggest otherwise. Any few of them would be a something to note, but generally nothing to be worried about given the history of the U.S. and global economy to accommodate some pretty extreme shocks and dislocations. But its just that sort of belief that may have lead to too much complacency. "That's the way its always been" is not a long-term sure-bet.
As well, more than a few analysts will tell you that if some of my concerns really mattered, the markets would have already suffered the fall-out.
Not necessarily; To paraphrase Charles Munger of Berkshire Hathaway fame, If you jump from the 42nd story building, your still doing fine when you pass the 27th floor. But that does not mean you don't have a serious problem.
So, without further ado, here is my outline list of concerns for 2006 and beyond.
- Massive National Debt ($8 Trillion equals $25,000 per citizen, old and young)
- Off balance-sheet unfunded Federal obligations (Takes the obligation figure above to $100,000 per citizen, according to the Comptroller General of the United States)
- Politicians that can't say "no" or "budget cut" = massive ongoing budget deficits.
- Energy Inflation ($60 oil from $13 in 1998-9) will cut disposable income.
- Real Estate post bubble uncertainty re price valuations (will slow home equity extraction and subsequent spending, and squeeze speculative home investors)
- Interest-rate-dependent economic expansion: What happens when rates rise above these historic below average lows? (Low rates encourage expansion, tightening rates encourage recessions.)
- Adjustable and interest only mortgages: what will rising rates do to hit disposable income when the teaser rates end?
- Global trade imbalance: US accounts for 70% of world's external deficits, requiring massive lending from foreigners - overly dependent on the U.S. consumption miracle.
- China Boom vs. Slowdown - excess capacity could lead to even more deflationary pressure for U.S. business.
- American Consumer in a weak state, and likely to back off discretionary spending:
- Lacking income growth support (Stagnant wages — -wages increasing slower than inflation over past few years).
- Savings short
- Overly-indebted (consumer debt to GDP at record levels)
- Asset growth dependent (the $600 billion "home equity ATM")
- Pay it down (at the expense of consumption/ economic growth);
- Default on it;
- Pay it off with cheaper dollars by printing money / inflation.
I know that's a big list. But in an environment where many folks tell you the economy is ready to take off, or that a concern here or there is nothing to worry about, I disagree firmly. Indeed, while superficially we may see some OK GDP or inflation numbers, we can't ignore core structural problems lurking just below the surface. If more than a few of these problems mature, it becomes ever more likely that more from the list will come into play in a sort of geometric fashion.