Be berry berry careful....

There are some signs in the markets that perilous times may be in the near (next quarter) future.  None of them are blatantly apparent (mainly because hype TV usually refrains from talking in depth about potential danger signs.  However, investor sentiment is at very high levels (usually very bearish signal).  Interest rates keep sneaking higher, and with government sales of treasuries expected to be even higher this year than last year's ridiculous numbers, this could be very dangerous.  If rates keep increasing, beware, this will instantly bring a halt to the "recovery."  Recently, several large closed end high yield bond funds have had major selloffs.  The last two times this happened - fall 2007 and winter 2008-2009.  Also, the long awaited (but hardly ever mentioned on TV) flow of ARMs and Alt-A mortgages that were the rage at the end of the housing boom to entice financially less stable players into houses they likely shouldn''t have bought, will start resetting their interest rates early this year.  The peak of these resets probably won't occur until 2011 though.   However, people that were previously making very minimal payments on their houses will be in for a rude awakening very shortly.  Given a high percentage of these players are either out of a job, on a reduced work schedule or shouldn't have bought the thing in the first place, another (potentially crippling) downswing in the real estate markets is very possible.  Throw in increasing interest rates, an already weak economy, a government stretched to and maybe beyond its capacity in debt, and you have a recipe for disaster.

Do not be fooled by the "great" numbers that have been flooding the markets.  This has been completely fueled by the government's ridiculous spending habits.  The liquidity has been propping our economy up now for some time.  However, how can we keep growing without free money (keep in mind nothing is really free)?  Yet how can we continue to keep adding on more debt?   Herein lies the problem.  Out of the 2 TRILLION dollars of debt the government issued last year, only 1/10 of it (200 billion) was purchased by someone other than our own government or agencies of it.  So you see there is hardly any desire to purchase our debt by investors or foriegn entities, and in essence we created 1.8 TRILLION dollars out of thin air last year. 

If our economy is doing so well, why is the fed keeping interest rates artificially so low?  They know raising rates would be deadly because our economy is still in extremely bad shape.  They can only keep rates artificially low for some time.  Eventually the market will say no more.  At that point the only way that rates will be able to stay low is if the fed essentially begins to buy up more and more and more of the outstanding treasury market, ie create more money out of thin air.  At this point, the dollar would begin to plummet.

The three scenarios I see at this point are:  1)  The market forces our government to it's senses in the form of a bond dislocation (essentially rates spike up).  The market would likely crash.  As long as the government doesn't try to solve this with some extremely massive spending bill, the dollar would likely rally hard.  2) Our government continues the status quo.  The dollar continues to get weaker over time (with a possibilty of rapid decline).  The stock market continues to rise, but day-to-day living will become much more expensive over time.  This could last for a few years, but eventually it can't go on, and scenario one comes into play anyway.  3)  The government gets spending under control, the fed walks the tight rope perfectly, housing rebounds, GDP growth gets to about the 5-6% and unemployment gets down to 6% for the next 10 years (these are the assumptions the White House used for what is needed to pay off our national debt and budget outlays), and we come out of this all happy.  The problem with this scenario - government and fiscally responsible together is a joke, the fed rarely ever is on top of things until it is too late, bubbles (housing) rarely rebound in under a decade (the Nasdaq is still 50% below its 2000 highs), and GDP growth of 5-6% would be about 3% above historical norms.  Throw in that it would have to occur for 10 years and we have a very unlikely scenario. 

I know I have been rambling, but this is very complex.  I've tried to simplify it.  I could probably write for another hour or more on this.  Life is good right now on Wall Street, but in Main Street America things haven't changed much.