The Five Biggest Threats to the U.S. Economy for the Rest of 2018

The U.S. economy is on a remarkable bull run that extends well beyond the stock market.
Economic activity is proving impervious to political administrations, natural disasters and government shutdowns.

Unemployment is down to 4.1 percent, essentially full employment, according to economists. Here are the highlights:

• The stock market is booming – the Dow Jones Industrial Average is up roughly 32 percent year over year.
• Gross domestic product is over 3 percent, and the New York Federal Reserve’s “Nowcast” index stood at 3.94 percent for the fourth quarter 2017.
• Tax reform triggered an upsurge in U.S. corporate spending, with more than 200 companies announcing plans to return a chunk of their tax savings to employees, customers and shareholders.

So why are so many leading financial and economic officials signaling the alarm for increased market risk? That scenario is very real, with these potential roadblocks in play for the financial markets for the duration of 2018, according to experts:

A dicey U.S. housing market. “I'm very worried that we're making the same kinds of mistakes in the housing market that we made in 2006, 2007 and 2008,” said Stephen Moore, a former economic advisor to President Donald Trump, at a recent Intelligence Squared debate.
“Fannie Mae and Freddie Mac, which I think were at the center of the crisis, providing 100-percent guarantees on mortgages with low-percentage down payments, was a catastrophe,” Moore said. “We’ve learned nothing” from the financial crisis.

“Fannie and Freddie and other government units, like the Federal Housing Administration, are doing the same thing,” he added. “I worry that we could see another housing panic.”

A failure to diversify overseas. Investors often assume large U.S. domestic stocks are less risky than other parts of the market because they are familiar names, noted Karyn Cavanaugh, senior market strategist at Voya Investment Management.

Because of the hefty S&P 500 return in 2017, investors are loading up on U.S. stocks, Cavanaugh explained. However, the MSCI Emerging Market Index returned 37.8 percent and the MSCI EAFE Index returned 25.6 percent in 2017, she said.

“Exposure to these overseas equities in a portfolio would have boosted returns, but more importantly, they would have decreased risk,” she said. “Investors are mistaken in thinking international equities are too risky. Because of their low correlations to U.S. stocks, they decrease the risk of the portfolio and potentially increase returns.”

Inflation. The biggest risk investors face today is inflation, said Graham Summers, president and chief market strategist at Phoenix Capital Research in Washington, D.C.

“Since 2010, the markets have been dominated by a fear of deflation,” he said. “This can be seen the ratio between treasury-inflation-protected securities (TIPS) and the Long-Term Treasuries ETF (TLT).”

In its simplest form, when this ratio rallies, the financial system is anticipating inflation, he added. When this ratio falls, as the current downtrend (from 2010 to 2017) shows, the financial system is anticipating deflation.

This is an “absolute game-changer,” Summers said. “It tells us the bond market is signaling an inflationary shock is coming. Given that the entire financial landscape has been operating based on the assumption of lower yields, this is going to catch many investors by surprise.”

Low risk an issue. “What I'm worried about in 2018 is the lack of fear that I have and so many others have,” said Jason Furman, former White House chief economist under President Barack Obama, at the Intelligence Squared debate.

The price of risk right now is very low, he said, while expectations are very high.

“There's some chance of a Wile E. Coyote moment where you look down and there's nothing beneath you, and you keep going down,” Furman said. “That's not my prediction for the year. But if it happens, you can say I put a 30 percent chance on it. It would happen with a much more dramatic revaluation of interest rates across the board, something that governments, businesses, and private investors aren't fully prepared to handle.”

A Bitcoin burst, as investors turn to gold. The Bitcoin bubble will finally pop, leading the way for gold to become one of the best investments for 2018, said Jillian Vorce, co-founder at the Jillian Group.

That does not mean the exuberance around Bitcoin is about to end, she added.
“Until it hits real mainstream … we still have room to run,” she said. “Bitcoin could go to 100,000 before it drops below 1,000.”

If and when that happens, expect a run to precious metals – especially gold.

“Interest in gold, which has been subdued as of late with all the cryptocurrency speculation, will regain popularity,” Vorce said. “When the bubble in Bitcoin finally bursts, investors will create an avalanche sized move to find safety.

“Gold comes roaring back to make new all-time highs, eventually becoming the best performing asset class in 2018.”

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].

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