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Farrell: Forget About Dubai—Worry About This

The oil rich Emirate of Abu Dhabi, the richest by far of the United Arab Emirates (UAE), seems set to support the runaway younger brother of Dubai. Exactly how is not yet certain but the markets seemed content enough with what was said that we got back to business as usual, at least for the moment. It is hard to tell how the situation will work out and/or whether it will still act as a trigger for a broader correction in the "risk" oriented trades. It could be shrugged off as unsurprising since, as the Wall Street Journal reported on Monday, "investors have known for months that Dubai World was dangerously indebted."

Dubai Palm Island
Photo Source: AP
Dubai Palm Island

Dubai's debt is almost equal to its GDP, but it's only about 20% of the total debt of the UAE.

So if the generous big brothers want to work something out it shouldn't be too much of a problem.

What might be a problem would be Greece, Ireland, Hungary, Bulgaria, Romania and Bahrain (among others) all of which have debt to GDP way above international norms with some approaching debt to GDP of 100%.

A few of the aforementioned countries are members of the European Union and could it be reasonable to think the EU would come to their rescue if push came to shove and debts couldn't be rolled over? I would question that but we might have a chance to see soon enough. For comparison total government debt in the US is now about 40% of GDP but climbing rapidly. Some, like Noriel Rubini, famed bearish economist, think debt will approach 80% of GDP before too long.

The problem could well come to a head if, as the New York Times wondered in its Monday edition (page A-3), "the global private debt could metastasize into a debt crisis for governments that are (already) running mounting deficits." And the US itself has to roll over/newly finance trillions and there is always the possibility we crowd the others out.

Two things to keep an eye on would be the level of the 10 year US Treasury bond yield. If it were to go below 3% (not a prediction by the way) then we would be in a major flight to safety that would bring other markets down. I also would look to the BRIC's (Brazil, Russia, India, and China), but especially Russia for signs of instability. India just reported a blockbuster third quarter GDP of 7.9% and they may well have to consider raising interest rates soon. China is China and Brazil has been an island of stability. That leaves Russia and since it is a major economy (Hungary, Bulgaria, Romania mentioned above are all small) with something like $75 billion in debt coming due the next year or so, keeping an eye on their credit default spreads and its currency could give an indication of spreading trouble. So far there has been no adverse reaction to the Dubai situation.

Back at the US ranch, Monday saw the Chicago Purchasing Managers Index register a surprisingly good 56.1. Consensus had been for 53, and October's number was 54.2. Above 50 indicates expansion. Within the report was a reading for inventories and the contraction in inventories started to ease with that sub-component rising from 32.2 to 34.9. The way I would interpret this is sooner or later the shrink in inventories will be reversed as orders will not be able to be filled out of the depleted inventory stock. Production will have to increase. As mentioned many times, just going flat line on inventories would be a significant boost to GDP.

Also, the SIA (Semiconductor Industry Association) reported that orders for October continued the momentum that started early in the third quarter. Revenues declined, but only 8% month over month, better than the -19% we have been seeing. Unit shipments were off -3%, much better than recent trends and pricing was better. Nick Tishchenko of Soleil/Analytics Investments feels "industry fundamentals remain strong." His "favorite name for the very near term is Verigy" (buy rated: recent price $10.25). "The stock trades below its tangible book value of $10.69 with net cash and investments of $5.12. His price target of $14 represents a P/E multiple of approximately 23 on his FY 2010 Earnings Per Share of $.60."

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Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.