Part I: Roubini Talks Risk, Recovery And The Threat Of A Triple Dip Recession

Oct 20 2014 | 9:57am ET

What keeps renowned economist Nouriel Roubini up at night? In a wide ranging interview with FINalternatives’ editor-in-chief Deirdre Brennan, the professor and chairman of Roubini Global Economics discusses the challenges facing the global economy, including the threat of a hard landing in China, the risk of a triple dip recession in the Eurozone and the possibility of a stalled U.S. recovery.

In this, the first part of this two-part interview, Roubini focuses on the U.S. economy, the end of quantitative easing and his outlook for the U.S. stock market. (View Part II)

The U.S. appears to be one of the bright spots in the global economy. What risks could derail the current U.S. 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.

And connected to that I would say the household sector is divided. Wealthy people are doing well. But you have a large number of households that have a very [few] assets so they don’t benefit much from inflation. They have a lot of debt that is being refinanced at low interest rates, but at some point rates are going to go higher, and while the labor market is improving, many people have jobs now that don’t create a lot of wage growth. Wage growth has been anemic. So the balance sheets of these households are fragile—lots of debt, very little assets and their P&L in terms of income generation is still sort of mediocre. You add to that $1.3 trillion of student loans, you add to that still a significant level of household debt for those who don’t have many assets, you add to that the sharp increase in subprime auto loans and so on, and you have a picture of where maybe the U.S. recovery is going to be more fragile than people make it.

You mentioned the Fed raising interest rates. What is your prediction of when that will happen?

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.

What is your outlook for the U.S. Stock Market?

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.

View Part II of the interview—which focuses on global growth, IMF policies and geopolitical risks.

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