The Category 5 Hurricane That Has Not Yet Hit

By the grace of God, we dodged a major bullet with Hurricane Gustav. It was great to see the country come together, to see the levies hold, and to see the Government pull off a successful massive evacuation. Unfortunately, there are still people who are negatively impacted by nature’s wrath and our hearts and prayers go out to those affected.

Anytime a massive hurricane builds in the Atlantic, the forecasters are pretty gloom and doom. Fortunately, we have continued to dodge major bullets. New Orleans under water would have been a major bullet. It makes you wonder, “At what point, do we face the big one? At what point are we not so fortunate?”

I feel the same way with the banking system. We see all of the ingredients for the Category 5 hurricane. We have thus far been able to dodge the big bullets. Yes, we have had some casualties (to name a few…Bear Sterns, Country Wide, and the list of banks that have not made it). However, we have been fortunate to avoid facing anything horrific.

We are right at the height of hurricane season. With two other major storm systems in the Atlantic, this has the potential to be a tough stretch. At the same time, we are also entering into a tough stretch for the stock market with all of the ingredients of a Category 5 hurricane.

The last four months of the year have the potential to be explosive one way or another. In bull markets, the last four months of the year have proven to be great investing opportunities. In bear markets, the last four months have proven to be problematic.

This should be an especially interesting four-month stretch. Let’s take a look at the dynamics going into the last four months.

- A barrel of oil has dropped -25% in about 1 ½ months. This is the bright spot as gas prices continue to fall. Ironically, politicians complain about the speculation effect driving up the price of oil. What about the manipulation effect of politics driving down the price of oil?
- Banks remain in crisis mode. Last week, the FDIC reported that their list of problem banks increased by 30% in the second quarter.
- Going into this Friday’s job report, we have had seven straight months of job losses. Call it what you want – with or without the official negative growth numbers, this is a recession.
- The S&P and the Dow Jones are down roughly -11% for the year.
- Most importantly, we have one of the most important and tightest elections in our history in November. We are also a nation that is extremely divided.
- We have what looks like 3 monster storm systems that have developed in the Atlantic. This looks to be an active hurricane season.
- We are locked firmly in a bear market.

What is my take? Although there remain many factors to be concerned about, my greatest concern is the banking system. Banks are having a tough time raising capital. Banks have billions of dollars of debt coming due in the final four months of the year. The ability for an economy to produce and supply credit to individuals and businesses is crucial for future development and growth.

Therein lies the problem. The credit markets are still in lock down mode. There has never been a greater need for credit. The only credit available comes with high interest rates. Thus far, we have been able to get by in this high risk situation. How long does that continue?

This is the financial storm that concerns me the most for those who are not prepared.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.