Nouriel Roubini's Global EconoMonitor

The Year of Betting Conservatively

The upswing in global equity markets that started in July is now running out of steam, which comes as no surprise: with no significant improvement in growth prospects in either the advanced or major emerging economies, the rally always seemed to lack legs. If anything, the correction might have come sooner, given disappointing macroeconomic data in recent months.

Starting with the advanced countries, the eurozone recession has spread from the periphery to the core, with France entering recession and Germany facing a double whammy of slowing growth in one major export market (China/Asia) and outright contraction in others (southern Europe). Economic growth in the United States has remained anemic, at 1.5-2% for most of the year, and Japan is lapsing into a new recession. The United Kingdom, like the eurozone, has already endured a double-dip recession, and now even strong commodity exporters – Canada, the Nordic countries, and Australia – are slowing in the face of headwinds from the US, Europe, and China.

Meanwhile, emerging-market economies – including all of the BRICs (Brazil, Russia, India, and China) and other major players like Argentina, Turkey, and South Africa – also slowed in 2012. China’s slowdown may be stabilized for a few quarters, given the government’s latest fiscal, monetary, and credit injection; but this stimulus will only perpetuate the country’s unsustainable growth model, one based on too much fixed investment and savings and too little private consumption.

In 2013, downside risks to global growth will be exacerbated by the spread of fiscal austerity to most advanced economies. Until now, the recessionary fiscal drag has been concentrated in the eurozone periphery and the UK. But now it is permeating the eurozone’s core. And in the US, even if President Barack Obama and the Republicans in Congress agree on a budget plan that avoids the looming “fiscal cliff,” spending cuts and tax increases will invariably lead to some drag on growth in 2013 – at least 1% of GDP. In Japan, the fiscal stimulus from post-earthquake reconstruction will be phased out, while a new consumption tax will be phased in by 2014.

The International Monetary Fund is thus absolutely right in arguing that excessively front-loaded and synchronized fiscal austerity in most advanced economies will dim global growth prospects in 2013. So, what explains the recent rally in US and global asset markets?

The answer is simple: Central banks have turned on their liquidity hoses again, providing a boost to risky assets. The US Federal Reserve has embraced aggressive, open-ended quantitative easing (QE). The European Central Bank’s announcement of its “outright market transactions” program has reduced the risk of a sovereign-debt crisis in the eurozone periphery and a breakup of the monetary union. The Bank of England has moved from QE to CE (credit easing), and the Bank of Japan has repeatedly increased the size of its QE operations.

Monetary authorities in many other advanced and emerging-market economies have cut their policy rates as well. And, with slow growth, subdued inflation, near-zero short-term interest rates, and more QE, longer-term interest rates in most advanced economies remain low (with the exception of the eurozone periphery, where sovereign risk remains relatively high). It is small wonder, then, that investors desperately searching for yield have rushed into equities, commodities, credit instruments, and emerging-market currencies.

But now a global market correction seems underway, owing, first and foremost, to the poor growth outlook. At the same time, the eurozone crisis remains unresolved, despite the ECB’s bold actions and talk of a banking, fiscal, economic, and political union. Specifically, Greece, Portugal, Spain, and Italy are still at risk, while bailout fatigue pervades the eurozone core.

Moreover, political and policy uncertainties – on the fiscal, debt, taxation, and regulatory fronts – abound. In the US, the fiscal worries are threefold: the risk of a “cliff” in 2013, as tax increases and massive spending cuts kick in automatically if no political agreement is reached; renewed partisan combat over the debt ceiling; and a new fight over medium-term fiscal austerity. In many other countries or regions – for example, China, Korea, Japan, Israel, Germany, Italy, and Catalonia – upcoming elections or political transitions have similarly increased policy uncertainty.

Yet another reason for the correction is that valuations in stock markets are stretched: price/earnings ratios are now high, while growth in earnings per share is slackening, and will be subject to further negative surprises as growth and inflation remain low. With uncertainty, volatility, and tail risks on the rise again, the correction could accelerate quickly.

Indeed, there are now greater geopolitical uncertainties as well: the risk of an Iran-Israel military confrontation remains high as negotiations and sanctions may not deter Iran from developing nuclear-weapons capacity; a new war between Israel and Hamas in Gaza is likely; the Arab Spring is turning into a grim winter of economic, social, and political instability; and territorial disputes in Asia between China, Korea, Japan, Taiwan, the Philippines, and Vietnam are inflaming nationalist forces.

As consumers, firms, and investors become more cautious and risk-averse, the equity-market rally of the second half of 2012 has crested. And, given the seriousness of the downside risks to growth in advanced and emerging economies alike, the correction could be a bellwether of worse to come for the global economy and financial markets in 2013.

This piece is cross-posted from Project Syndicate with permission.

5 Responses to “The Year of Betting Conservatively”

princess1960November 20th, 2012 at 7:11 pm

ok if i wanted to see just the economic side to your columne I have to say is very correct and you are right ..( i hop is just economic analysis) because if is and political my bad mind send to me to some your intreses with arabic world AND Iran (i know you are birth there) but this doesn't mean your focus is untill this limit.
you know i Love your very very good work like economict and i try to learn from you .
respect ..
ps .Iran Arab spring ..and what others have is not in right direction for the world …
remember this.

Walter MichelNovember 21st, 2012 at 1:19 am

You may be able to add in civil war between the Kurds and the central government of Iraq pretty soon too. Hard to say what military/political strife may actually become a problem in the near future, but there seems to be more and more hot spots worldwide.

RKARYANovember 27th, 2012 at 1:26 pm

the crux of the article is that demand would slacken as no more fiscal stimulus is possible in major countries. but the quantitative easing has negative impact on the growth as interest rate is almost zero. the money tend find route to emerging economies, there is as rally in the stock market but it has to be responded by the indication of real growth. as the growth in India is not showing any sign of improvement, the rally is dead and correction start taking place.

Erico WulfNovember 27th, 2012 at 2:29 pm

It looks like 2013 will be a year to forget about .
I guess the only positive side of next year , it is that it will be hard to have a copy of it !.
2013 will be the year of corrections (upwards or downwards).
a.-Upwards because austerity policies should be revisited, unless a long recesion is considered the only option.Besides, the situation of weaker european countries and the euro, should also be revisited (two speed euro zone ?). New leadership in China, might improve expectations of inward looking based economic growth.
b.- Downward: too much QE (zero interest rate),might become harmful for productive investment. The fiscal cliff inthe USA economy, will get its share of Economic growth. Besides, the global geopolitical situation is becomig more unstable ,and it will also take its share on growth,and as Mr Roubini says ,the equity market correction is already under way..
Thus , 2013 will the year in which political leadership can make the difference. Economic policy tools are stretched up to its limits.

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