Two Potential Potholes on Wall Street

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Wall Street's three days of doldrums this week, putting a dent what has been an impressive market-wide comeback from the lows of late March, have mostly been dismissed as a short-lived combination of pre-holiday weekend profit-taking and Jeffords-defection unease. But in a Q&A, TIME personal finance columnist Daniel Kadlec wonders if the markets may be setting themselves up for a fall at a time when the overall economy is still very shaky.

What's the biggest trouble spot you see right now?

Daniel Kadlec: The big item right now is the uptick in long-term bonds.

When Greenspan cuts rates, it's the long-term interest rates he's really targeting, not the short-term ones the Fed actually influences. Long-term bond traders tend to look at the five- and ten-year outlook, because the inflationary picture over the long haul is what really affects the price, in interest, of a ten-year loan.

That those bond yields are up right now means that bond traders have gotten too optimistic about the Fed's moves — they're acting like the recovery is already under way, like we're in a normal-growth economy already. Which we clearly are not.

Greenspan went out Thursday night (in a speech to the Economic Club of New York) and basically said the bond markets have it wrong — the economy is still weak, and that he may not be done cutting rates, and by extension, those long-term bonds ought to come down.

If they don't, that's trouble for the recovery that still has to happen, because those long-term bonds are what determine the price of a mortgage. If you raise the cost of a mortgage, you're putting a damper on not only home sales but the refinancing cash that's been fueling a lot of the consumer spending this spring. If those long-term interest rates stay high, there's a threat that the bond markets could kill the very recovery they're anticipating.

And the other?

The techs. The rapid recovery in tech stocks is too much, too soon. We're starting to get that feel-good aspect again of owning techs as some kind of get-rich lottery ticket. There's some speculation creeping back into the market already — I still think we've hit bottom, but a 40 percent rise in just two months? We could be building another bubble, if a smaller one, and the higher and faster we go up, the more chance there is of a sharp downturn.

Mostly it's been the professionals driving stocks back up. But if the individual investor starts jumping on board now, they could really get hurt.

Besides those individual investors, what's the danger for the economy?

Consumer confidence. Consumers still need to spend at a good clip to get us from this point — maybe six months from a Fed-induced recovery — to the recovery itself, when businesses will start to step in. There's still a lot of announced layoffs that haven't hit workers yet, and with energy prices still worrying people, another big market sell-off could kill whatever consumer confidence is left.