This column originally appeared on Real Money Pro at 9:40 a.m. EDT on June 25.NEW YORK ( Real Money) --
"And there will be strange signs in the sun, moon, and stars. And here on earth the nations will be in turmoil, perplexed by the roaring seas and strange tides." -- The Holy Bible, Luke 21:25 (New Living Translation)Despite the recent turmoil, the U.S. stock market is seen almost universally by strategists and investors to have limited downside risk. This unanimity of opinion should concern everyone. It sure concerns me! Given this consensus view of limited downside market risk and a general lack of fear, it seems timely to consider 10 reasons why the market might be vulnerable to a more meaningful downside. 1. U.S. economic growth slows more than consensus. Led by a pause in the housing market and a turndown in retail sales, the trajectory of domestic growth disappoints in the second half and into 2014. Most notably, the residential real estate market, which has been the straw that stirs the drink of the U.S. economy, falters under the weight of a gap in home prices (double-digit increases year over year) combined with a spirited climb in conventional mortgage rates. These two factors serve to deliver a near-30% rise in the carrying cost of the average mortgage and jeopardize the recovery in housing demand that has taken place over the past two years. Home prices reverse lower in the months ahead, owing to higher mortgage rates/lower affordability, the supply of foreclosed properties put on the market and because of the reduced involvement of new-age institutional buyers of property and homes (hedge funds, et al.). In turn, this has the effect of denting household net worth, consumer confidence, personal expenditures, GDP and ultimately corporate profits. The Fed chairman's 3% real GDP growth projection over the balance of the year misses dramatically. Real GDP grows by only +1% to +2% over the next seven quarters. The low level of actual nominal growth provides little top-line growth, a difficult challenge to profitability -- 2013 S&P profits come in at only $103 a share, and consensus projections for next year are lowered to under $100 a share. The entire notion of a self-sustaining recovery (unaided by more monetary accommodation) comes into question. Market participants come to the conclusion that the U.S. economy requires continued (but unlikely) quantitative easing. Investors come to accept that the U.S. is in some form of liquidity trap (light) with attendant negative implications for profits, dividends, share buybacks and merger and acquisition activity.
- Perhaps it is an extreme drought in the U.S., Brazil and/or Russia, which could result in much higher commodity and food prices, adversely impacting the consumer's purchasing power.
- Maybe it is another major flash crash or a series of mini flash crashes that inject market uncertainty.
- Or a coronal mass ejection in which the sun emits solar flares that penetrate the Earth's atmosphere and initially wipe out most GPS systems and disrupt numerous communications systems, electronic devices and power grids all over the world.
- Or maybe an event that is entirely not expected such as a political coup or a liquidity event emanating from a company, sector or region not anticipated.