Risk is a four-letter word and a four-letter word.
While Merriam-Webster defines risk as the "possibility of loss or injury," the word has taken on the same meaning as a gaggle of other four-letter words that I can't reprint here. The reason is obvious -- investors all over the world took on risk in the run-up of the credit bubble, not really understanding what they were signing up for, and the results have been disastrous.
The Federal Reserve and the U.S. Treasury, though, have been fighting hard against the consequences of failed risk by throwing money at the financial system. And at least right now, that seems to be paying off.
The Treasury turnabout
According to Bloomberg, primary dealers with the Treasury had a short position in Treasuries of $10.5 billion last month. That may sound like some sort of foreign lingo, but it's important. You see, primary dealers typically make bets against Treasuries, as a hedge on riskier bets such as those on corporate or mortgage bonds. So the existence of a net short position suggests that financial companies such as Goldman Sachs (NYSE: GS ) , JPMorgan Chase (NYSE: JPM ) , and Bank of America (NYSE: BAC ) are once again making loans of all types.
Though the measure rose back to a net long position of $16.2 billion at the end of last week, that's still well below the record level of $93.6 billion in June. And hey, in this environment, we'll take what we can get, right?
Corporate spread -- the difference between corporate bond yields and Treasury yields -- has also been narrowing, and was at 3.82% last week after peaking at more than 8% in March. Other measures of lending spreads show similar trends. And all of this reinforces the idea that investors are loosening up a bit after the panic of last year.
Back to Kansas?
But don't get too excited there, Dorothy. The question that faces us now that we're creeping back to "normal" is, what does normal actually mean. If you ask PIMCO's Bill Gross, you get a sobering account that the "normal" to which we're returning is a "new normal." Deleveraging, deglobalization, and regulation will mean that economic growth, profit growth, and stock market growth won't look anything like what we're used to in recent history.
Gross contends that the demons that still haunt us -- represented by companies like AIG (NYSE: AIG ) and Fannie Mae (NYSE: FNM ) , but actually widespread throughout the U.S. economy -- will keep a surging recovery and a quick-step economic growth rate under wraps. He also notes that the U.S. is reaping the whirlwind of moving away from being an economy that made things, toward one that instead relied on printed money and asset values.
A Grossian economic scenario would mean that investors betting on a healthy recovery for companies like Home Depot (NYSE: HD ) and Target (NYSE: TGT ) could be in for a reality check.
Most economists seem to be singing a similar tune; a Bloomberg survey of economists showed the average estimate for next year's growth to be 2.3%. It would seem that they also see dark clouds spoiling any stock market picnic in the near future.
Economists versus analysts
But not everyone is on the same page as Gross.
In more Bloomberg research, the average Wall Street analyst estimate for the S&P 500's profit growth in 2010 was a whopping 25%. In stark contrast to the dour predictions of Gross and economists, that would suggest that the S&P's price today is still cheap. It would appear that one of these groups is off the mark here. The historical relationship between profit growth and economic growth would suggest a GDP jump of 4.1% to support that heady 25% number.
This Fool is siding with the economists. I expect that the coming years will provide positive movement, but make our economy look more like the tortoise than the hare. But what do you think? Take the poll below to log your opinion on where the economy is headed. Then scroll down and fill up the comments section with your explanations.
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