By Anthony Mirhaydari
Article from MSN Money
The doomsayers are out in force, and we do have plenty to worry about. But just how likely are double-dip demons and creepy credit collapses?
If you want a good scare -- a nightmarish, dead-of-night, cold-sweat scare -- you don't need haunted houses or horror movies. Just open the financial pages. There's plenty of frightening stuff in there.
Although stocks are well off their early October lows and economic growth is rebounding nicely, consumer and investor sentiment remains 6 feet under. In fact, consumer confidence in October plunged to the lowest level seen since the recession. Only 11% of respondents to the survey said conditions were good; compare that to the 44% who said conditions were bad.
And the doom mongers are working overtime.
Witness the overnight YouTube fame enjoyed by independent trader Alessio Rastani after a wide-eyed interview with BBC News. Or the ongoing success of doom-leaning blogs like ZeroHedge and pundits such as Glenn Beck. Or suggestions that some left-wing revolution will emerge from Occupy Wall Street. Or the prediction by the Economic Cycle Research Institute that we're headed for a new recession and there's nothing anyone can do to stop it.
Frightened by market volatility, America's credit downgrade and gloomy news out of Europe, people are taking action. Some have moved out of stocks and into cash or gold. Others are stockpiling food, seeds and ammo. (I have the emails to prove it.)
The thing is, as I've been saying for weeks, the economic fundamentals are actually turning positive. It's time to ignore the ghouls and goblins; it's time to get the bull horns on, if you know what I mean.
Here's a look at four scary economic stories lots of people is obsessing about, and why they're more Michael Jackson's "Thriller" than Freddy Krueger's "Nightmare on Elm Street" (amusing, rather than terrifying). We'll start with a quick take on why even the most realistic one, a double-dip recession, shouldn't keep you up at night.
Scary story No. 1: The double dip
After tepid results earlier this year, economic growth is on track to come in at nearly a 3% annual pace in the third quarter, thanks to strong retail spending and business investment. The job market is enjoying momentum not seen since springtime. Industrial production is rebounding at home and overseas. And internal measures of stock market strength -- such as the number of stocks participating in the up days -- have reached levels not seen since the move out of the March 2009 bear market low.
Eurozone Crisis
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Third-quarter reporting season has been solid so far, with 69% of the Standard & Poor's 500 Index ($INX +0.56%) companies that have reported thus far producing better-than-expected results, thanks to strong numbers from the financial sector.
Business confidence, which tends to lead consumer sentiment, is already on the upswing. Jeff Immelt, the CEO of General Electric (GE +2.94%, news)and the head of President Barack Obama's job-creation task force, said that his company's two big businesses -- energy and aviation -- have "extremely strong (order) backlogs" and that he expects strong profit and revenue growth next year. Donald Washkewicz, CEO of manufacturer Parker Hannifin (PH +1.69%, news), said: "If we haven't talked ourselves into a double dip by now, we probably won't, because we've been talking about it for the better part of two quarters here."
Credit Suisse economist Neal Soss is even warning of a "speed-up scare" that would catch a lot of people by surprise, while UBS economist Paul Donovan believes a recession outlook "is unrealistic" right now. Does any of this sound like a new recession?
But there are still three other Armageddon scenarios floating around out there worth knocking down, starting with the failure of the euro.
Scary story No. 2: Eurozone collapse
The worst-case downside of Europe's debt crisis is a catastrophic death spiral. It starts with Greece defaulting on its debt, igniting a financial crisis that spreads to Italy (the world's third-largest debt market), France and, eventually, the United States. Then comes the collapse of the euro and the European Union -- and bank failures in Europe that spread worldwide.
These fears are the reason U.S. bank stocks were hit so hard this year, with the Financial Select Sector SPDR (XLF +0.46%) exchange-traded fund falling nearly 36% from its February high to its October low.
But in reality, Europe seems to be getting its act together. Greece, despite deadly protests outside its parliament building, passed a tough new austerity budget. Leaders from the European Central Bank, the International Monetary Fund and the European Union, short of time and under intense pressure, are moving toward a comprehensive solution to what once seemed an intractable problem.
A broad outline is coming together, tough as it may sound. Eurozone banks will have to write off more than 100 billion euro -- roughly $139 billion -- worth of Greek debt and patch the smoldering hole left on their balance sheets with help from asset sales, private investors and, ultimately, their national governments and the eurozone's bailout fund. Greece, along with Italy and Spain, would face years of budget cuts and an austere future. And the stronger countries -- Germany and France, for example -- will have to pony up cash to persuade investors to re-enter the eurozone debt market.
At its core, Europe is struggling with hard realities: too much debt, too little competitiveness in some countries, political complexity and the inability to use traditional tools -- like currency devaluation -- to solve its problems. But there's hope. Witness Ireland's quick recovery after last November's bailout; the gross domestic product has averaged 1.8% growth this year as foreign investment bounces back.
In fact, the euro nations have strong motivations to head off doomsday.
UBS economist Stephane Deo has calculated the costs of the darkest scenarios, putting price tags on things like currency fluctuations, trade disruptions and credit crunches. Her analysis finds that for a small country like Greece to leave the eurozone would cost more than half of GDP in the first year -- around $16,000 for every Greek man, woman and child. For a strong country like Germany, the cost would be around 25% of GDP -- $6,000 per German.
There would be political costs as well. Europe would lose its global influence. Deo also notes that almost no modern currency unions have broken up without some kind of authoritarian or military takeover, or civil war.
A bailout is much cheaper. If Germany bailed out Greece, Ireland and Portugal entirely in the wake of a default, the cost would be just $1,400 per German.
Scary story No. 3: Chinese meltdown
Another big worry floating around is that all's not right in China. There are concerns about the health of the banking system, from overzealous borrowing by local governments to the rise of informal, underground lending designed to skirt Beijing's rules. There are also worries about the so-called "hard landing" scenario that sees the Chinese economy stalling as exports to Europe and the United States slow.
Indeed, UBS China economist Tao Wang wrote in a recent note to clients that "listening to news coverage and pundits, one could be forgiven for thinking that China is on the verge of a debt crisis on the same scale as the European sovereign debt crisis or the U.S. subprime crisis."
What makes this so scary is that a crash in China, the world's third-largest economy, would send ripples far from the shores of the Yellow Sea. Bank of America-Merrill Lynch economists estimate that a 2% drop in China's growth rate would hit Malaysia, Singapore, South Korea, Taiwan and Hong Kong. A deeper drop of 4% would spread to Europe and the Middle East, with growth hits in Russia, Kuwait and Finland. The last time we saw a hit to growth of that size was in the wake of the Lehman Brothers bankruptcy, the core of the credit meltdown.
A full-on crash, which the economists describe as a 6% reduction in growth, would hit Europe's largest economies as well as that of the United States. What's worse is that China's woes could trigger new debt crises as a global economic slowdown -- driven by China -- complicates the eurozone crisis and forces another downgrade of the U.S. Treasury.
I don't have to tell you the kind of trouble we'd be in if each of the world's three largest economies were embroiled in its own financial panic.
But again, the details suggest a brighter picture. Wang stresses that the informal lending market in China is relatively small and that the risks are exaggerated. Moreover, the hard economic data are beginning to improve. This week we learned that the HSBC China flash manufacturing index had moved back into expansionary territory for October, rising to a six-month high of 51.1 from 49.8. (Any reading over 50 indicates month-over-month growth.)
The team at Capital Economics believes the PMI data supports their view that "China's economy has at least been stabilizing." Encouraging signs include the fact that more than half the pickup in the PMI number was due to strength in the new orders component. There was a big increase in export orders as well.
All of this suggests the Chinese economy will continue to gather steam in the months ahead.
Scary story No. 4: A U.S. default
While everyone's been focused on Europe lately, it's easy to forget that the most dramatic phase of the May-October market decline was spurred by the Standard & Poor's downgrade of the U.S. in the wake of the downright embarrassing debt-ceiling debate. This resulted in some of the worst panic seen in the financial markets since the fall of Lehman Brothers because it questioned the creditworthiness of the venerable U.S. Treasury bond, the world's reserve asset of choice.
These are supposed to be the "risk free" investments by which all other assets are judged. If they're not, the shock waves reverberate. For investors, stocks and bonds are suddenly less valuable. For businesses, capital investment opportunities are suddenly less attractive. And for banks, capital reserves are suddenly less safe.
Here's what's scary: We could be headed for a repeat performance.
With Washington still mired in partisan bickering, hopes are fading that the so-called congressional "supercommittee" will be able to agree on a plan for medium-term budget consolidation through tax hikes and spending cuts. Failure to deliver an agreement by Nov. 23 will trigger $1.2 trillion in automatic spending cuts -- focused on defense outlays -- and likely result in additional downgrades to the U.S. credit rating.
Moody's could be the next to act; analysts there have already slapped a negative outlook on the United States and sent a cryptic warning that a lack of a deal "would be negative information." Another downgrade would resurrect fears surrounding the U.S. fiscal situation and the potential for sudden austerity to slam the brakes on already halting growth.
Instead, as I've argued before, we need a responsible mix of short-term stimulus combined with a long-term commitment to balancing the budget and tackling the tough choices that are needed on the entitlement programs, especially health care spending.
I'll admit it: Of the scary stories I've outlined here, this is the one that worries me most. Bank of America-Merrill Lynch economist Ethan Harris believes at least one credit downgrade will happen in late November or early December. Markets dropped 7% on the day of the S&P downgrade; Harris expects a smaller impact this time.
Yet the possibility of a real default -- the U.S. actually not paying its debts -- remains remote.
In fact, this Halloween it's probably better to scream over ghosts and goblins than over these economic horror stories. You'll have plenty of time to worry as we run toward the 2012 election -- when the partisan warriors will be in full battle regalia.
Washington will have three time bombs to defuse in that time: a major spending cut, a major tax increase and another debt-ceiling decision. Watch for the talk of a U.S. default to pick up steam once again.
And you'll have to take a hard look at whether any of the politicians on the ballot can fix what ails our economy. That could be very scary indeed.
Names worth considering
Meanwhile, I still see the economy performing better than most expect over the next few months. I continue to recommend investors focus on aggressive, cyclical stocks including Russian steel-maker Mechel OAO (MTL -11.58%, news), which is up more than 33% since I recommended it on Oct. 4. I've recently noticed a shift into financial and emerging-market stocks including State Street (STT +0.90%, news) and Petrobras (PBR +0.23%, news) -- both of which I've added to the Edge Letter sample portfolio.
I've also recommended ING Group (ING +2.18%, news) to my newsletter subscribers; it is up 32% since we added it in late September on my expectation of a positive resolution to the eurozone crisis.
At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column in his personal portfolio. He has recommended ING Group to subscribers of his newsletter.
Be sure to check out Anthony's new investment advisory service, the Edge. A two-week free trial has been extended to MSN Money readers. Click the link above to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter.
Stocks mentioned on previous page: General Electric (GE +2.87%, news) and Parker Hannifin (PH +1.65%, news)
Turn the hopelessness within you into a fruitful opportunity.