Professor Nouriel Roubini, chairman of consulting firm RGE Monitor and professor of economics at the Stern School of Business, New York University, began his remarks at the Globes Finance and Capital Markets Conference by presenting six questions that interest every investor and capital market player. "There are at least six important questions on the table," he said. "The first: We have experienced the most severe crisis; is the worst behind us or not, and what is going to happen to the financial sector? The second question is, what is the state of the US economy: Is the recession over? How hard is it, and when will it end? The third: We have a slowdown in the entire global economy. How long will it last.
The fourth question is, should we worry about inflation of deflation in the global economy? The fifth: What monetary or fiscal policy is required to solve the crisis? And the sixth and most interesting question is, what are the consequences of all this for financial assets? What will happen to stock markets, government bonds, corporate bonds, real estate, and so on?
1. Is the worst behind us?
"There is good news and bad news. The good news is that compared with the months after the collapse of Lehman Brothers our situation is relatively good. There's more liquidity, insurance, and collateral in the market, and the risk has fallen significantly since then. That's the end of the good news. When we look at the balance sheets of the banks in the US and Britain, the situation is still not good.
"The pressure tests weren't pressured enough. Data from the labor market are already worse than those taken for the purposes of the pressure tests. They estimated that overall losses would be $2.7 trillion, but that's far from our estimates. It's no longer just a matter of sub-prime mortgages, but of all kinds of mortgages and securitizations.
"The hole in the financial system is very big, and the strategy --- to give these banks more time to solve their problems by themselves --- looks mistaken. More aggressive action is needed for them to recover."
2. Is the recession in the US over?
"The US economy is in a deep recession that began in 2007. There were those who thought that the recession would be V-shaped, and there are economists like me who predicted that the recession would continue for at least 24 months and would be U-shaped. We are in the middle of the U."
3. How long will the global slowdown last?
"The optimists claim that we are close to the bottom and that the recession will end in the current quarter or the next one. I agree that, compared with the situation in the two last quarters, the recession is slowing. The US economy will continue to post negative growth until the end of the year, and next year growth will not be close to 2% or more, but 1% or less. We have rising unemployment, many enterprises in distress, and many other factors indicating that the economy will continue to be weak.
"I see the light at the end of the tunnel, but the recovery will be weaker than people think, and it will come in another six months, not next month.
"Most of the emerging economies will not only post slower growth, but actual negative growth. This is the first time in the past 60 years that we have a synchronized global crisis. The global economy did not just sneeze; it caught a serious cold."
4. Are we facing inflation or deflation?
"In the next two years, the great problem for the global economy will be deflation, not inflation. Companies have no pricing power, they have to cut prices to get rid of stocks. The labor market indicates falling wages and worker layoffs, which weakens purchasing power. Oil and commodities prices have been cut sharply. All these things indicate emerging deflation, not inflation. Of course, in the future we will see an inflationary problem, but we will have to deal with that only in another three years, as soon as the weight of the labor market falls off us."
5. Monetary or fiscal policy?
"We won’t solve the liquidity problems on the market as long as we fail to deal with the banks properly, and monetary policy alone won’t help in that respect."
6. What will be the future effects?
"In my opinion, the rally on the stock market in the past couple of months is a bear market rally and not the start of a bull market. The stock market falls sometimes when people see a recession and a recession doesn't arrive. In the past two years, every time something dramatic happened, such as the events at Bear Stearns, Lehman Brothers, and AIG, the market fell because of the bad news, and the administration tried to rescue them, and people thought that was the bottom, and were proved wrong. It leads to a rally of a few weeks and then evaporates.
"Six times in succession we have seen this in the latest crisis. This zig-zag has gone on for the past two years. The more time passes, the more the temporary low can be the real low of the crisis. Today we are apparently nearer the bottom than we were a year ago, but I'm bearish on the markets, because there is more bad news to come for the stock market too.
”Company profitability Is not going to recover too much in the coming weeks, and the banks in the US have more big problems that will weigh on the financial markets. While the markets are close to the bottom, they can still fall as a result of more negative news, and therefore I think that a market correction is still ahead, and investors should be cautious over risky instruments, such as stocks in the US and the world. The recovery is not going to be fast."
"A tough year for the Israeli economy"
Roubini devoted a part of his remarks to the Israeli economy, and said that, "On the whole, the fundamentals of the Israeli economy are strong. This is an open and dynamic economy with a strong technology sector. I see a possibility of solid growth in the Israeli economy.
"There are of course also challenges along the way, such as reforms that need to be instituted. The problem is, of course, that since Israel is an open economy, it is also open to problems in the developed markets, such as the US, Japan, and others.
"This is going to be a tough year for the Israeli economy. Israeli policy makers must continue introducing structural economic reforms, and then they can avoid the storm and register stronger recovery when the global economy recovers."
Talking to "Globes" after his lecture at the conference, Roubini talked about his projections for the future.
You have been very pessimistic in your projections since 2006. What will cause you to alter them and identify a change?
"I'm pessimistic, but I would prefer to be optimistic. I would be glad to forecast the bottom for the global economy. I see the end of the recession at the end of the year, and I'm less pessimistic about growth in the two following years. I'm not too pessimistic.
"I would change my mind if I were to see the loss of jobs continue at a slower rate. I will change my mind if I see a change in consumers' disposable income. Confidence in the banks needs to come back."
You said that the recent rises are a bear market rally and that the markets will fall again. But it could be that these rises are a correction of an extreme distortion of prices that came about after the collapse of Lehman Brothers.
"The share price correction occurred over the past year and a half, in line with the crisis. There were bubbles in many markets, as in China and India. In my view, this rally brings stocks to a position in which they are reasonably priced from a historical perspective, and given the global crisis. It may be that there will be a further correction, not to the low we saw in March, but a correction of 15%, before we see signs of real recovery.
"I wouldn't be surprised at that. People need to be optimistic on the basis of real information and not on the basis of expectations."
First quarter company financials are behind us, and the fear of a sharp drop in activity was vindicated. What happens next?
"In my opinion, if there's a recession and companies' pricing power is limited, the consequence will be negative for companies and shares. If profits don’t recover at the expected speed, the market will be bearish."
They say the end of every crisis is the beginning of a new one. Where is the next bubble?
"My fear is that if a cash surplus is generated that finds its way into stocks, commodities, and other instruments, there is a risk that, as we did in 2004-2006, we will create a new bubble, for example in commodities. But it could happen again in shares, when everyone flocks to them."
Published by Globes [online], Israel business news - www.globes.co.il - on May 13, 2009
© Copyright of Globes Publisher Itonut (1983) Ltd. 2009