Nouriel Roubini's Global EconoMonitor

The Uptick’s Downside

From Project Syndicate:

Since late last year, a series of positive developments has boosted investor confidence and led to a sharp rally in risky assets, starting with global equities and commodities. Macroeconomic data from the United States improved; blue-chip companies in advanced economies remained highly profitable; China and emerging markets slowed only moderately; and the risk of a disorderly default and/or exit by some members of the eurozone declined.

Moreover, under its new president, Mario Draghi, the European Central Bank appears willing to do anything necessary to reduce stress on the eurozone’s banking system and governments, as well as to lower interest rates. Central banks in both advanced and emerging economies have provided massive injections of liquidity. Volatility is down, confidence is up, and risk aversion is much lower – for now.

But at least four downside risks are likely to materialize this year, undermining global growth and eventually negatively affecting investor confidence and market valuations of risky assets.

First, the eurozone is in deep recession, especially in the periphery, but now also in the core economies, as the latest data show an output contraction in Germany and France. The credit crunch in the banking system is becoming more severe as banks deleverage by selling assets and rationing credit, exacerbating the downturn.

Meanwhile, not only is fiscal austerity pushing the eurozone periphery into economic free-fall, but the loss of competitiveness there will persist as relief at the waning prospect of disorderly defaults strengthens the euro’s value. To restore competitiveness and growth in these countries, the euro needs to fall towards parity with the US dollar. And, while the risk of a disorderly Greek collapse is now receding, it will re-emerge this year as political instability, civil unrest, and more fiscal austerity turn the Greek recession into a depression.

Second, there is now evidence of weakening performance in China and the rest of Asia. In China, the economic slowdown underway is unmistakable. Export growth is down sharply, turning negative vis-à-vis the eurozone’s periphery. Import growth, a sign of future exports, has also fallen.

Similarly, Chinese residential investment and commercial real-estate activity are slowing sharply as home prices start to fall. Infrastructure investment is down as well, with many high-speed railway projects on hold and local governments and special-purpose vehicles struggling to obtain financing amid tightening credit conditions and lower revenues from land sales.

Elsewhere in Asia, Singapore’s economy shrank for the second time in three quarters at the end of 2011. India’s government predicts 6.9% annual GDP growth in 2012, which would be the lowest rate since 2009. Taiwan’s economy fell into a technical recession in the fourth quarter of 2011. South Korea’s economy grew at a mere 0.4% in the same period – the slowest pace in two years – while Japan’s GDP contracted at a larger-than-expected 2.3%, as the yen’s strength weighed down exports.

Third, while US data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011. Moreover, given continuing malaise in credit and housing markets, private consumption will remain subdued; indeed, two percentage points of the 2.8% expansion in the last quarter of 2011 reflected rising inventories rather than final sales. And, as for external demand, the generally strong dollar, together with the global and eurozone slowdown, will weaken US exports, while still-elevated oil prices will increase the energy import bill, further impeding growth.

Finally, geopolitical risks in the Middle East are rising, owing to the possibility of an Israeli military response to Iran’s nuclear ambitions. While the risk of armed conflict remains low, the current war of words is escalating, as is the covert war in which Israel and the US are engaged with Iran; and now Iran is lashing back with terrorist attacks against Israeli diplomats. The Islamic Republic, with its back to the wall as sanctions bite, could also react by sinking a few ships to block the Strait of Hormuz, or by unleashing its proxies in the region – the pro-Iranian Shia in Iraq, Bahrain, Kuwait, and Saudi Arabia, as well as Hezbollah in Lebanon and Hamas in Gaza.

Moreover, there are broader geopolitical tensions in the Middle East that will not ease – and that might intensify. The Arab Spring has produced a relatively favorable outcome in Tunisia, where it started, but developments in Egypt, Libya, and Yemen remain far more uncertain, while Syria is on the brink of civil war. In addition, there are substantial concerns about political stability in Bahrain and Saudi Arabia’s oil-rich Eastern Province, and potentially even in Kuwait and Jordan – all areas with substantial Shia or other restless populations.

Beyond the countries affected by the Arab Spring, rising tensions between Shia, Kurdish, and Sunni factions in Iraq since the US withdrawal do not bode well for a boost in oil production. There is also the ongoing conflict between the Israelis and the Palestinians, as well as strains between Israel and Turkey.

In other words, there are many things that could go wrong in the Middle East, any combination of which might stoke fear in markets and lead to much higher oil prices. Despite weak economic growth in advanced economies and a slowdown in many emerging markets, oil is already at around $100 per barrel. But the fear premium could push it significantly higher, with predictably negative effects on the global economy.

With so many risks in so many places, investors, not surprisingly, will eventually prize liquidity in their portfolios, while shunning riskier fixed assets again when these tail risks materialize. That is yet another reason to believe that the global economy remains far from achieving a balanced and sustainable recovery.

15 Responses to “The Uptick’s Downside”

BD MacIsaacFebruary 17th, 2012 at 3:47 am

Yes, good synopsis. I like to think of you as Dr. Sensible versus the "Dr. Doom" label the fake media stuck you with.

Thanks for continuing to crank the articles out.

Aegean1972February 17th, 2012 at 2:00 pm

The article is spot-on!

It always amazes me how well-informed Nouriel Roubini is on an international level.
Not only in financial matters but also from a political viewpoint. Because politics affect the economy in a major way and a wise analyst considers those factors (as well as many others) before "predicting" a possible outcome.

He is a wise voice of logic, for those who listen and those who understand the many complex thoughts, the many factors that are considered in ones mind in order to "predict" something.

And off course predict it right.

Rassegna web: K. Fisher, N. Roubini, la Lehmann-Grecia e altro « Trading WarriorsFebruary 19th, 2012 at 2:27 pm

[…] Sul fronte opposto il nome è sempre lo stesso: Nouriel Roubini. Con così tanti focolai di crisi in aree del pianeta totalmente diverse non sorprende che gli investitori tengano ancora tanta liquidità in portafoglio, proclama Doctor Doom. L’economia globale è ancora ben lungi dall’essere arrivata a un livello di ripresa equilibrata e sostenibile. Quello che vale per gli investitori non necessariamente vale per i traders. Senza contare i pianisti che suonano un solo tasto: short. (leggi l’analisi di Roubini su […]

golowguyFebruary 22nd, 2012 at 1:21 am

Roubini is not unlike every other economist that got the clock right once and hired a PR firm to become the resident genius. If I'm not mistaken, this is the same gy that warned everyone he could back in Aug/Sept of 2011 – the the Dow was around 11,000 that we were headed for a major decline. The Dow is now nearing 13K, eventually he'll "nail it" again. Another celebrity gas bag. You're better off being prudent and do your own due diligence.
BTW, has the Middle East ever been unstable during the last 3,000 years? Genius?

Richard GordonMarch 1st, 2012 at 9:04 am

Of course you are entitled to your opinion but I personally enjoy Roubini's clarity and common sense. He also has a large depth of knowledge that is a great resource for investors and the business sector. In a few short paragraphs he is able to sketch out a clear picture of the economic landscape. That's what I look for in an economic commentator, not a soothsayer.

Lanky YankeeFebruary 22nd, 2012 at 3:17 am

Hey gologuy – having a bad day? Dr. Roubini's comments are always interesting and oft times very thought provoking. I try to be prudent and do my own due diligence – and articles provided by Dr. Roubini and his staff are a welcome part of that due diligence. Here's hoping he continues to be the resident genius and rakes in tons of money – all the better to keep his enterprise afloat and via the Economonitor continue to provide great market intelligence at no cost to guys like you and me.

EzioPFebruary 22nd, 2012 at 4:22 pm

There are few key drivers we should look at: the first is the real economy which is not expanding due to the people lack of confidence in the future; the second one is the financial economy which is in trouble because of its tendency to keep the liquidity rather than to fund enterprises and families; the third one is the reflection of the two above on the people that is more oriented to save, if possible, or to defer spending, hence not pushing the growth of the real economy. This latest is the most critical point because, in its power, it can influence the growth and, or the inflation depending on the finance policy in place. The policy in place, at EU and IMF level, to save the banking system although is good for the banks budget is not good for the real economy because the banks are keeping the liquidity rather than to finance enterprises and families. In other words the money doesn’t flow to sustain the real economy harm but only to the limited financial one.

JQK in MooselandFebruary 26th, 2012 at 11:50 pm

And the population is ageing, leading to less spending now and longer term. We had better knuckle down for the long haul and make choices wisely from here on – unlike the recent thirty years of nonsense. No energy policy (keep paying the Saudis), no constraint on health care spending, and another proposed war after the last and current one will do it! Sayanaro!

Doug C.March 1st, 2012 at 1:40 pm

Thoughtful, accurate article. Everything said is true, and the risks are real. However, these risks are known and understood in the market. The question for us as investors is – do his insights and predictions allow investors to either preserve capital and/or make money? Over the last 5 years Roubini’s prominent words of caution have been right once (’08/’09) and wrong once (’09-today). That’s 50/50. So his predictions are as accurate as – flipping a coin?

materialsriskMarch 2nd, 2012 at 4:37 pm

I agree with your assessment of the key economic risks facing the global economy at the moment; the Euro debt crisis, unrest in the Middle East and the potential for a hard landing in China.

However I do wonder whether investors / businesses have become numb to the latest developments in Brussels/Athens as the crisis has seemingly stretched on and on. I think that the latest bailout and action by the ECB are still just aiming to buy time and it wont be long before a third much bigger bailout is required as unrest intensifies later in the year.

On the Middle East I think Thursday's market reaction to news of a pipeline explosion in Saudi Arabia is telling, in that I would expected a much sharper price increase given the supposed nerves in the market. I personally think the Iran risk premium in the current crude price is a very small component of recent price increases.

On China the January trade data and also electrical production were very suggestive towards a sharper slowdown. However recent PMI data has been much more supportive of China maintaining relatively strong growth. What concerns me about China is not so much this year but later on in 2013/14 when the country's bad loans are likely to catch up with it.