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Risk: when it rains, it pours …

It’s resurfacing. Perhaps not in the exact same places or at the exact same frequency or with the exact same magnitude, but things are resurfacing.

For a good many months there we had been harping on the US dollar’s potential to rally on risk aversion. We regularly brought to light the lingering risks and new risks that could have ultimately flipped the investing environment on its head again. But during that time our expectations were suppressed by the markets; risk appetite was surprisingly resilient, investors surprisingly accepting.

So is now the time to go all in? Is now the time to bet on everyone else taking their money off the table here?

Let’s look at what’s happening:

– Real estate in the US is still in trouble or about to be in trouble. The recent chaos around the foreclosure fraud in the US is really just delaying an enormous number of inevitable foreclosures yet to hit the market. Banks are way behind on processing foreclosures. The outlook for prices is for a decline of 8% or more.

– We know of the potential bubble in China that’s on the verge of bursting. Home prices there have not yet shown notable downside, but sales volumes are slumping and the impact of decreasing demand would hurt the builders and the raw materials providers, in turn having a harmful impact on an economy that could come unraveled all at once … very soon. Hong Kong, too, is taking action. They’re raising down payment requirements and taxes on speculative sales in hopes of slowing down surging home prices which the IMF recently said could rock the Hong Kong economy.

– QE2 is still the devilish plot by the Federal Reserve to debase the US dollar and increase US competitiveness in global trade. Or, in different words, it is a way for the United States to force adjustment on its trading partners who remain reliant on undervalued currencies and their export-centric growth models. The point is: China and other emerging markets are not amused; and smaller emerging economies in particular face sizeable capital inflows — both into emerging market funds and direct investment – and the potential for inflation and asset bubbles.

– A growing number of institutions, analysts, economists and know-it-alls are characterizing central banks’ actions as hazardous bailouts for the banking system. The term “Ponzi Scheme” is being used regularly. Main Street is still suffering, despite a lot of recent improvement in various economic data points; this recovery seems built on a wet foundation. At the same time, focus remains on shoring up the banks, partly for confidence building reasons and partly for reasons on which the public can only speculate. But the ideas are not good. Basically, Main Street types are losing confidence in Wall Street types; the recent investigation into insider trading among hedge funds adds to the mystery of dark pools, computerized trading programs, fraud, corruption and an un-level playing field. This uncertainty does not bode well for US investments.

– In case you’ve been living under a rock, Eurozone sovereign debt concern is boiling over again. The interconnectedness of the eurozone banking system and another economy surfacing in need of a bailout (Portugal and Spain next?) suggest the can is simply being kicked down the road to the doorstep of national governments where, when all piled together, will be too onerous to manage. Here is a chart that was put together by the IMF in October to show exposure to Greece, which is significantly smaller in scope than Ireland relative to the part it plays in the financial sector:

– China is still being dealt criticism over its mercantilist trade policy and the manipulation of the Chinese currency. Apparently they’d like to use their leverage on rare earth metals to silence the haters. And now they’ve got another volatile issue to tend to: Korean tensions. China, being North Korea’s most useful ally, is being pressed to do some pressing on the North Koreans. Simply: markets do not like geopolitical tensions. And if there seems potential for the two largest global economies to take opposing sides (albeit not likely at this point), markets are going to like it even less.

-Last but not least the stock market — all that QE2 love seems to be gone. The stale, overused, unsubstantiated phrase, “Don’t fight the Fed,” is proving useless as usual. In a world focused on risk, stocks look like they have a whole bunch of air in them.

S&P 500 Index (black) versus US$ Index (red) Daily:

Happy Monday!