Wednesday, October 29, 2014

Factors that could ruin the US economic recovery

On the baseline, we see U.S. economic growth close to 3% in the second half of this year into next year. I would say that the things that could derail the U.S. recovery are either external factors or domestic factors.

External factors are [first] that the global economy looks like it’s running on a single engine, the one of the U.S.—the other three major ones are sort of stalling. The Eurozone is at risk of deflation and triple dip recession. Japan has been hurt by fiscal contraction following the consumption tax, and China is quite sharply slowing down. So of those four engines of global growth, the U.S. seems to be the only one that’s still running. And that’s a problem because eventually that’s not sufficient. Some of those global slowdowns can affect the United States.

Two, one of the manifestations of that global slowdown and the relative growth differential between the U.S. and the rest of the world has been the appreciation of the U.S. Dollar. So far it’s orderly and the impact on growth is modest, but if the appreciation of the U.S. Dollar were to accelerate, then the impact on growth could be, over time, more significant.

The third aspect of the global economy that might affect the U.S. is, of course, geopolitical risk. Those risks so far with the Middle East or Russia/Ukraine have not had an impact on the markets, but I would say so far the impact has been contained because there hasn’t really been a shock to the supply of gas and oil. But you can see a scenario if those geopolitical risks were to escalate, then the impact on the U.S. could become more significant. So those are the global factors.

Among the domestic factors that can derail the recovery is, first of all, the recovery is still not exceptional in spite of all this monetary stimulus. It has been so far anemic...So there’s a question mark of whether the U.S., like other advanced economies, may be at risk of secular stagnation, a combination of high levels of private and public debt, and a rise of inequality and debt redistributing from those who spend to those who save. An additional point is that as the Fed now ends QE and gradually starts raising rates, there’s a question of whether the U.S. economy can tolerate the rising short rates and long rates that the exit from QE and from zero policy rates will trigger. There is still too much private debt, and there is still too much public debt. We think that the U.S. economy can withstand it, but it’s an open question mark.

Monday, October 27, 2014

Fed could raise rates next year

I think that the lifting of zero policies is going to be around June of next year. That would be my point estimate. It could occur slightly sooner if the economy really recovers strongly. It could be a little bit later if global factors justify waiting until July or so, but I would say sometime in the year. 

Monday, October 20, 2014

Roubini predicts 5 percent upside to stocks

I would say U.S. stock prices have risen significantly since the global financial crisis. Earnings growth is slowing down. Even top line revenues are somehow slowing down. P/E ratios are slightly above historical averages if you take Shiller’s CAPE. [In other sectors] they’re meaningfully above historical averages, and in some sub-sectors—like tech, biotech, social media—they have P/E ratios that just don’t make any sense.

So, there are three forces that are going to be driving the U.S. Stock Market ahead. Some acceleration of growth should be positive for earnings. Some slowdown in earnings in top line and bottom line because they cannot keep on growing much faster than GDP forever. And the global factors might imply that the components of earnings of S&P that come from the rest of the world are going to disappoint. And three, however slowly short and long rates might go higher, that would be a headwind to U.S. equities. 

So, the net of it would be, say, next year U.S. equities going up maybe by 5%, not more than that. So still positive returns, but not the kind of returns we have seen in the last couple of years. That will be our baseline on U.S. equities. 

Monday, October 13, 2014

Markets could suffer in the following scenario

Nouriel Roubini cites the reasons he believes the stock markets around the world could get ugly.

The Middle East turmoil could affect global markets if one or more terrorist attack were to occur in Europe or the US - a plausible development, given that several hundred Islamic State jihadists are reported to have European or US passports. Markets tend to disregard the risks of events whose probability is hard to assess, but which have a major impact on confidence when they do occur. Thus, a surprise terrorist attack could unnerve global markets.

Markets could be incorrect in their assessment that conflicts, like that between Russia and Ukraine, or Syria's civil war, will not escalate or spread. Russian President Vladimir Putin's foreign policy may become more aggressive in response to challenges to his power at home, while Jordan, Lebanon and Turkey are all being destabilised by Syria's ongoing meltdown.

Geopolitical and political tensions are more likely to trigger global contagion when a systemic factor shaping the global economy comes into play. For example, the mini-perfect storm that roiled emerging markets earlier this year - even spilling over for a while to advanced economies - occurred when political turbulence in a few countries - Turkey, Thailand and Argentina - met bad news about Chinese growth. China, with its systemic importance, was the match that ignited a tinderbox of regional and local uncertainty.

Today (or soon), the situation in Hong Kong, together with the news of further weakening in the Chinese economy, could trigger global financial havoc, or the US Federal Reserve could spark financial contagion by exiting zero rates sooner and faster than markets expect. The Eurozone could relapse into recession and crisis, reviving the risk of redenomination in the event that the monetary union breaks up. The interaction of any of these global factors with a variety of regional and local sources of geopolitical tension could be dangerously combustible.

While global markets arguably have been rationally complacent, financial contagion cannot be ruled out. A century ago, financial markets priced in a very low probability that a major conflict would occur, blissfully ignoring the risks that led to World War I until late in the summer of 1914.

Back then, markets were poor at correctly pricing low-probability, high-impact tail risks. They still are.

Wednesday, October 8, 2014

Reasons why markets have performed well so far

An increasingly obvious paradox has emerged in global financial markets this year. Despite the fact that geopolitical risks - the Russia-Ukraine conflict, the rise of the Islamic State and growing turmoil across the Middle East, China's territorial disputes with its neighbours and now mass protests in Hong Kong and the risk of a crackdown - have multiplied, markets have remained buoyant, if not downright bubbly.

Indeed, oil prices have been falling, not rising. Global stock markets have, overall, reached new highs. And credit markets show low spreads, while long-term bond yields have fallen in most advanced economies.

Yes, financial markets in troubled countries - for example, Russia's currency, equity and bond markets - have been negatively affected. But the more generalised contagion to global financial markets that geopolitical tensions typically engender has failed to materialise.

Why the indifference? Are investors too complacent or is their apparent lack of concern rational, given that the actual economic and financial impact of current geopolitical risks - at least so far - have been modest?

Global markets have not reacted for several reasons. For starters, central banks in advanced economies - the United States, the Eurozone, the United Kingdom and Japan - are holding policy rates near zero and long-term interest rates have also been kept low. This is boosting the prices of other risky assets, such as equities and credit.

Markets have taken the view that the Russia-Ukraine conflict will remain contained, rather than escalating into a full-scale war. So, though sanctions and counter-sanctions between the West and Russia have increased, they are not causing significant economic and financial damage to the European Union or the US. More importantly, Russia has not cut off natural-gas supplies to Western Europe, which would be a major shock for gas-dependent European Union (EU) economies.

The turmoil in the Middle East has not triggered a massive shock to oil supplies and prices like those that occurred in 1973, 1979 and 1990. On the contrary, there is excess capacity in global oil markets. Iraq may be in trouble, but about 90pc of its oil is produced in the south, near Basra, which is fully under Shia control, or in the north, under the control of the Kurds. Only about 10pc is produced near Mosul, now under the control of the Islamic State.

Finally, the one Middle Eastern conflict that could cause oil prices to spike - a war between Israel and Iran - is a risk that, for now, is contained by ongoing international negotiations with Iran to contain its nuclear program.

So, there appears to be good reasons why global markets have so far reacted benignly to today's geopolitical risks.