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Friday, 8 May 2009

Five things to worry about

NEW YORK (CNNMoney.com) -- Stocks were finally taking a bit of a breather Thursday.

And with GM reporting a $6 billion loss, the government finally set to announce exactly how much capital 19 big banks will have to raise as a result of the stress tests and most retailers posting same-store sales declines for April, can you blame investors for the pullback?

Sentiment has shifted at the drop of a dime, with people trying to find good news everywhere they look. And the fact that the market has gone from Chicken Little to Alfred E. Neuman (What, me worry?) in just two months has to be a concern.

I want to believe that this rally is for real and that the worst is over for the economy. I'm not one of those so-called perma-bears who will forever proclaim that the end is nigh. But there are still some potential pitfalls out there that could derail the recovery for the economy and stock market.

The banks aren't healthy yet. Yes, bank stocks have soared in the past two months. And the stress tests are likely to show that several big banks don't need to raise new capital. And those that will be required to do so are probably going to have to come up with far less than many investors feared a few months ago.

Still, that doesn't mean the banking system is completely fixed. The worst may in fact be behind them. But banks aren't showing the same confidence in themselves that Wall Street is. If they were, the credit crunch would be over.

"There is a sense that banks are not falling into a bottomless pit anymore," said Sean Snaith, director of the Institute for Economic Competitiveness at the University of Central Florida in Orlando. "But that's a far cry from saying the banking system is back on two legs. Until banks actually start lending again, you can't say the patient has recovered,"
Talkback: What risks do you see to a possible recovery?

There are also concerns that banks may still have to reckon with existing loans outside of residential mortgages and credit cards that haven't gone bad yet. In particular, some are worried that commercial real estate could be the proverbial next shoe to drop.

"If the financial sector's balance sheets don't heal, we won't get a recovery. Commercial real estate is a significant risk that could be another blow to banks," said Benjamin Reitzes, an economist with BMO Capital Markets in Toronto.

It's all about jobs. Even if the market continues to rally and housing prices stabilize, many consumers will continue to focus on the labor market as the main barometer of the economy's health.

It's hard to imagine how consumers will boost the economy through more spending if companies are still shedding hundreds of thousands of workers a month. Plus, there could be more job pain ahead, especially with Chrysler already filing for bankruptcy and GM (GM, Fortune 500) appearing to head down that route as well.

To be sure, the job market is a lagging indicator. So the unemployment rate probably won't start declining until well after the recession is over.

But Snaith said people won't necessarily take comfort in this fact, since the job losses in this recession are far worse than during the 2001 recession and so-called jobless recovery that lasted another two years. The unemployment rate peaked at 6.3% in 2003. It's already 8.5% and many economists think it could pass double digits before long.

"The job losses are more severe than the last recession. So the notion of a jobless recovery this time around is more troublesome," Snaith said.

Gas pains return. Don't look now, but oil prices are nearing $60 a barrel. And the average price of gas is now $2.14 a gallon. Sure, that's a far cry from last summer's record highs. But gas prices are up nearly a dime a gallon in just the past week.

The more that the broader markets rally on evidence of an economic recovery, the more likely it is that oil and gas prices will head higher as well, since investors in commodities may start speculating about a big increase in demand. And with summer just around the corner, the usual seasonal spike in gas prices should come into play.

Consumers do seem to be more confident, thanks to hopes that the housing market may be close to hitting bottom at long last. But this recovery is still tentative. If investors get ahead of themselves and gas prices skyrocket as a result, that could be a problem.

"Rising gas prices could weigh on consumer spending. It's not a big worry just yet. But consumers will take any help they can get and lower gas prices have helped," said BMO's Reitzes.

Trade wars on the horizon? Historians and economists have laid some of the blame for the Great Depression on President Herbert Hoover's protectionist trade policies.

Few expect history to repeat itself. But there are worries about the potential for trade wars to develop considering that there are some Buy American provisions in the stimulus bill that Congress passed earlier this year.

"One worry I have is protectionism. There are fears that some countries would look within in response to this crisis. Hopefully, that doesn't happen this time around," said Jeff Mortimer, chief investment officer of Charles Schwab Investment Management.

And considering that the global economy is far more interconnected now than it was 80 years ago, any steep barriers to trade could be disastrous.

Too far, too fast. Finally, the biggest risk to a comeback could very well be that investors are getting way ahead of themselves.

Again, I want to reiterate that I'm not predicting another depression. There are healthy signs that the economy is stabilizing.

But it's starting to look like investors are anticipating a rapid, stunning turnaround, the proverbial V-shaped recovery. Instead, the economy could bounce around on the bottom for a bit, something economists refer to a U-shaped recovery. So If hopes for a quick rebound are dashed, there could be trouble.

"The worst is probably behind us. But how good of a recovery will we get? It probably will be a weak recovery," Reitzes said. "People may be disappointed because they are overly optimistic and things aren't likely to improve at the rate they want to see."

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