Warning: Worldwide wipeout ahead

In many places, a perfect wave of growth has reversed into a brutal riptide. Indian information-technology companies such as Cognizant Technology Solutions (CTSH, news, msgs) and Wipro (WIT, news, msgs) swelled in importance by helping U.S. companies fix the "millennium bug" in the late 1990s and then went on to grow at 40%-plus rates as the tech outsourcing fad exploded.

Now, The Wall Street Journal reported this week, the Western credit crunch and capital expenditure slowdown have sapped sales, and the cheaper dollar has shrunk Indian tech company profits. At the same time, rising labor costs have permitted competition to emerge in lower-cost countries in Eastern Europe and the Philippines. The big Indian tech companies' shares are down 30% in the past 10 months versus a negative 18% for U.S. techs.

Meanwhile, fear has gripped corporate bond investors by the throat in ways that make stocks' problems look tame. Surely you remember bonds, those widows-and-orphans instruments that were once considered the market's equivalent of a boring IOU, paying a percentage point or two above U.S. Treasurys? Well, now many are trading like penny stocks.

You can call your broker to buy debt by the mortgage unit of blue-chip GMAC Financing at crash-landing prices that would give you a 50% annualized rate of return over the next three months when they mature in November. Or perhaps you'd prefer bonds of privately held plastics giant Pliant that mature in September 2009 and are going for 45%. Or bonds of car-parts maker Dayton Superior (DSUP, news, msgs) that mature in June 2009 for a yield of 40%. Or maybe Washington Mutual (WM, news, msgs) bonds maturing in January that trade around 35%.

I could go on and on. Credit analyst Brian Reynolds has sent clients a list of 60 major companies with bonds maturing over the next 12 months that trade with yields over 10% at a time when the federal funds rate is at 2%, adding in a note: "And these are just the bonds that have been able to trade!"

The Merrill Lynch Corporate Master Index, which tracks the performance of investment-grade-rated corporate bonds, shows 72 of them trading in "distressed" condition, or more than 10 percentage points over Treasurys -- 28 of them issued by banks such as regional giants National City (NCC, news, msgs) and Washington Mutual. That means corporate bankruptcies are virtually inevitable over the next 18 months. Chris Whalen, the managing director of Institutional Risk Analytics, has told Dow Jones Newswires that he expects 110 banks with $850 billion in assets to fail by next July, which is eight times the Federal Deposit Insurance Corp.'s reserves.

A spate of bankruptcies of this breadth is incompatible with a rising stock market even if the next president gets in front of the problem by creating a new government entity that buys failed banks, much like the Resolution Trust Corp., which closed 747 thrifts starting in 1989. So either the pessimistic credit guys and global-equity investors are terribly wrong right now, or the relatively optimistic U.S. equity investors are wrong. They can't both be right, as both depend on assessments of global earnings potential, with small variation for currency values.

Since credit has led the recent cycle down, and since the rest of the world's vote is overwhelming, I think we have to give a nod to the pessimists this time. The latest bounce should persist a little longer, but once the Dow Jones industrials ($INDU) climb to around 12,000 by early fall, watch out below.

Fine print

You can keep track of the health of corporate bonds at Bonds Online. Visit this page for timely foreign stock market charts.

ProShares has a variety of exchange-traded funds, or ETFs, that allow you to buy an instrument that trades inversely to stock and bond indexes. That provides a relatively easy way for both institutions and independent investors to short, or bet against, both markets and sectors.

If you're an optimistic contrarian, you could also fade the recent decline move by buying ProShares ETFs that provide double the positive return of the indexes. Click here to see them all. Credit markets analyst Reynolds is now macroeconomic strategist at WJB Capital in New York. See his bio here.

At the time of publication, Jon Markman did not own or control shares of any company mentioned in this column.

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