Monday, November 03, 2008

Reassessing Roubini's Predictions

Unfortunately for Roubini, there is no Nobel Prize in Economic for being the best predictor of global financial markets. Nouriel Roubini warns that the worst in markets and economies is yet to come. On October 23rd, Nouriel predicted the potential shutdown of financial markets. A day later U.S. stock futures suspended trading after declines of more than 6% at opening tripped the circuit breakers. Nonetheless, Nouriel does not expect another Great Depression, but states that policymakers must act quickly and wisely.

Here are the main elements of Nouriel’s outlook:

Tsunami of corporate defaults (I see some defaults in third tier companies not being able to roll over or secure new funding, but I doubt very much this tsunami of corporate defaults will happen as I still see this being largely concentrated in property, lending and banking. Yes, we are already seeing secondary effects on the broader markets but its not as debilitating as Roubini paints it out to be)

2-year U-shaped U.S. recession that threatens to turn into an L-shaped one if policymakers do not regain control of the financial system (Wow, L-shaped, I don't believe I have come across L-shaped recession recovery graphs in my economics textbooks ... if its not in textbooks, it should not exist, right... though the Japanese economy in 1990s looked very L shaped to me)

global re-coupling to the U.S. will advance from non-U.S. markets to non-U.S. real economies – not even the strongest emerging markets such as Brazil and China will escape global re-coupling (Why is Roubini talking of re-coupling, when there was no de-coupling in the first place? Mind you, all BRICs and Asian markets fell earlier and more severe than the US markets. If that's not evidence of markets NEVER ever having decoupled, I don't know what is?)

vicious cycle of deflation in goods markets, labor markets, commodity markets, financial markets, corporate and household earnings, and aggregate demand (Agree to an extent, but not a prolonged period. The basic roubini's thesis is de-leveraging = deflation, not true. De-leveraging has almost been completed, hedge funds are falling like a ton of bricks, the majority of the weak ones have closed shops already. Good thing about hedge funds, when things are bleak, they close shop very quickly... because no more 20% performance kicker, might as well close and lay low for a while, then reopen a new fund later)

de-leveraging to reduce excess debt in municipalities, households and some firms (As above)

U.S. stock markets declining another 20%-30%, bottoming fall 2009 at the earliest, then moving sideways for years post-recession if growth remains anemic as it did in Japan after its 1990s real estate and equities bust (Again being right for the first part of the call does not mean Roubini will get it right again, I think success has gone to his head. The Japanese experience was due to "inaction", banks were very slow to recapitalise, restructure or allowed to fail. Thats why it took them 15 years and growth is still flat. What the Japanese took 15 years to do, the US and European financial markets did it in 3 month. Roubini losing track of events)

U.S. unemployment rise to reach 8-9% (That is probable but not a prolonged phase because at that unemployment rate, the discount rate may very well go to zero, and we know what happens when there is negative real interest rates)

According to Nouriel, USD assets, commodities, U.S. and international equities, housing, and the USD are quite risky right now. Seek safety in cash or cash-like instruments such as T-bills and bonds of safe, large governments. Though he believes the U.S. dollar will retain its reserve currency status for decades, its status will gradually erode.

Given the size of the expected contraction in private aggregate demand (likely to be about $450 billion in 2009 relative to 2008), Nouriel argues that a fiscal stimulus to the order of $300 billion minimum (and possibly as large as $400 billion) will be necessary to partially compensate for the sharp fall in private aggregate demand.

I like Roubini a lot and he was brave enough to call and defend his views way before they came to fruition. But we should not be blinkered as well, I see some blind spots in his current predictions, as he seems almost "one-tracked-minded" on the whole shebang unfolding to the worst of his nightmares. But, what do I know, I am not a professor or an economist.

p/s photos: Im Ji Hye


easystar said...

"the discount rate may very well go to zero, and we know what happens when there is negative real interest rates"

I don't think we can be sure what happens when real rates are negative. US/Europe and Japan real rates have been negative (inflation-policy discount rates) for a good while and yet unemployment still rose.

Further, we are facing a world where 0% discount rates go into banks, but it does not come out at the loan rates. (Unless Fed allows corporation/consumer to borrow directly from itself..haha)

I am certainly no where as pessimistic as Dr Doom. The old adage said that the bear will eventually be right, but market can remain irrational for longer that one can remain solvent.

Also, Dr Doom seemed to have failed to see that Gold Prices would fall in this deleveraging cycle (he was telling people to buy gold)

One can also keep predicting that, say Maybank will disappear and I am sure one day it will disappear and the predictor will be eventually right.

Han Qiang said...

he mentioned 2 important points which i think you might have missed out. The spread between corporate bonds and treasuries remain elevated. CDS indices for investment grade remains high despite falling libor-ois and ted spread.

I verified his statement and realise that bonds spread remain high even for AAA-rated corporate bonds. This is significant because this suggest not only the third tier companies will be defaulting.

my 2 cent worth

Kris said...

The most important of all for Dr.Doom is that did he made serious money shorting the market when he predicted the October 2008 fall?

Talking is one thing..doing is :P


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