What Can Go Wrong

The S&P500 crept up another 0.9% last week, on declining volume.  The index is at extremely overbought levels, based on several technical indicators.  On a short-term basis, anyone who buys at this moment, is almost certainly buying at relatively high prices.

The economic data were mixed.  The Empire State Manufacturing survey was slightly stronger than expected, although it dropped on a month-to-month basis.  Both housing starts and permits fell, also on a monthly basis.  Producer prices and consumer prices were both benign, suggesting that inflation in goods and services (as opposed to asset prices) is not in imminent danger of accelerating.  Initial jobless claims were slightly worse than expected, as were leading indicators.  The Philly Fed came in a bit above the consensus forecast.

Now that the Fed has succeeded in reflating many asset classes in the US (and indirectly, around the world), what are some of the pitfalls that could trigger prices to fall suddenly and unexpectedly?

First let’s remember that NOTHING has been fixed with respect to the root problems–the total indebtedness of the US is still at record highs (375% of GDP) and the trillions of dollars in toxic assets (related mostly to residential and commercial real estate) and the derivatives attached to them have not been removed.

Everyone is pretending that the problem lurking beneath the financial landscape  will somehow magically go away.  Something will surely turn up, right?

So what can go wrong, especially in the short to medium term?  What could cause the financial monster to rear his ugly head again?

This is only a partial list of possible triggers:

1. A systemically important country could suffer a debt crisis.  Greece is the most visible.  But the list of other candidates is shockingly long–they include Spain, Italy, Ireland, Portugal, the UK, and Japan.

2. A currency crisis (most likely linked to a debt crisis) in many of the same nations and regions: the euro, the pound, the yen, etc.

3. A threatened bankruptcy in a US state–California, Illinois, New York and several others are near the brink.

4.  A global trade war, possibly linked to a breakdown between the US and China trade relationship.  This could cause China’s economy to nosedive, dragging with it the surging economies of Australia and Canada.

5. A market trading collapse, in the US, rooted in the failure of high frequency trading that today accounts for almost 70% of trading volume in the equity markets.

6. Geo-political shocks.  Israel-Iran, North Korea, Russia, and several non-government sponsored terrorist organizations could spark a conflict that would probably stun the fragile capital markets.

And the most likely trigger will probably NOT be on anyone’s list, making it seem even more shocking when it occurs. 

The point is that the financial system of the world is being held together by nothing more than bubble gum and tape.  And THIS is the underlying reason that the system will most likely enter into another crises.  The actual trigger is almost irrelevant.  Any number of known, and unknown, shocks can cause the system to collapse again.

And unless the underlying problems are corrected immediately, a collapse is almost guaranteed to occur.

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