I see a great sense of uneasiness from most investors today. Many people aren't quite sure why they feel this way and can't explain their inherent inertia. I think it is important to get very granular on what the risks are to the stock market and why people actually should feel unsettled.
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I have broken down four major risks to stocks and their forecasted earnings as we enter into the first half of 2012. I am genetically a Bull and believe stock prices over time will go higher. However, we cannot ignore the potential short-term threats that domestic stocks are currently facing. Anything that attacks forecasted earnings is what you should be worried about. Here are four major threats to earnings for U.S. Corporations in 2012.
• Europe represents 20% of the world's gross domestic product. The concern for Europe has many facets. However, one of the major problems is that if Europe's economy goes from having a cold to a severe flu, we will see their imports from the U.S. and around the rest of the world slow to a trickle. Here is the key factor: U.S. stock prices have risen in anticipation of announced and forecasted earnings. Stocks move six to nine months ahead of this information being announced. As the top 100 companies move, the rest of the market follows. Over 50% of the growth of these 100 companies is expected to come from outside U.S. borders. It is important for all investors to watch earning revisions from analysts because when we start to see lower earnings revisions that is a red flag to be concerned about. I believe there is a 15% chance that Europe will come out of 2012 unscathed and a 35% chance we will see the economic picture in Europe suffer dramatically.
• I believe that we will see interest rates on the long end of the yield curve in the United States rise. When this happens it will cause a negative ripple throughout the balance sheets of most U.S. corporations. Although as investors we often focus on the stock market, we must remember that most corporations fund their operations by issuing debt in the form of bonds. If interest rates rise, corporations will be required to pay more in interest payments and this will detract significantly from their earnings. I place a 50% probability on interest rates rising dramatically in 2012.
• Commodity prices are on the rise. We all hear that manufacturing has left the U.S. from most major corporations. Although this may be true, regardless if manufacturing occurs inside the U.S. or outside the U.S., rising commodities prices will hurt corporate earnings because it will cost more money for these corporations to manufacture their products. Although they often pass this additional cost onto the consumer, not all of those additional costs can be passed on. There comes a point where the consumer won't pay the ever-increasing price for the product brought on by rising commodity prices. This increase in costs to the consumer will translate into less purchasing power and as a result should hurt earnings for those companies. I place a 70% probability of this happening in 2012.
• Iran could be a wildcard. We read non-stop about the threat from Iran. However, most investors do not understand how a potential military action from the United States or other countries in that region will impact their portfolios. There are multiple detrimental results that will arise from this potential action but the greatest one is a disruption in oil distribution around the world. Even though we don't import oil from Iran, other countries do and if that oil flow is shut-off, there will be a significant impact on production and that will cause the price to skyrocket worldwide. Higher energy prices have a direct negative impact on everyone outside of the oil industry. I place a 60% probability of some disruption occurring in or around Iran in 2012.
All of these events will negatively impact the stock market and contribute to investors' reasons to be concerned. So if you are feeling uneasy and uncomfortable, now you know why you should be.
Ed Butowsky is an internationally recognized wealth manager. His upcoming book titled "Are You Committing Financial Suicide?" is expected to be released this spring.