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Those 'green shoots' are just a dead cat bounce, no recovery
By Nouriel Roubini |
April 15, 2009, Wednesday
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Print Edition
Print Edition
MILD signs that the rate of economic contraction is slowing in the United States, China, and other parts of the world have led many economists to forecast that positive growth will return to the US in the second half of the year, and that a similar recovery will occur in other advanced economies.
Investors are talking of a "green shoot" of recovery and of positive "second derivatives of economic activity" (continuing economic contraction is the first, negative, derivative, but the slower rate suggests that the bottom is near).
As a result, stock markets have started to rally in the US and around the world. Markets seem to believe that there is light at the end of the tunnel for the economy and for the battered profits of corporations and financial firms.
This consensus optimism is not supported by the facts.
I expect that while the rate of US contraction will slow from -6 percent in the last two quarters, US growth will still be negative (around -1.5 to -2 percent) in the second half of the year (compared to the bullish consensus of 2 percent).
Moreover, growth next year will be so weak (0.5 to 1 percent, as opposed to the consensus of 2 percent or more) and unemployment so high (above 10 percent) that it will still feel like a recession.
In the euro zone and Japan, the outlook for 2009 and 2010 is even worse, with growth close to zero even next year.
China will have a more rapid recovery later this year, but growth is likely to be below the average of 10 percent over the last decade.
Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow.
My latest estimates are US$3.6 trillion in losses for loans and securities issued by US institutions, and US$1 trillion for the rest of the world.
Many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses.
Given this outlook for the real economy and financial institutions, the latest rally in US and global stock markets has to be interpreted as a bear-market rally.
Economists usually joke that the stock market has predicted 12 out of the last nine recessions, as markets often fall sharply without an ensuing recession.
But, in the last two years, the stock market has predicted six out of the last zero economic recoveries - that is, six bear-market rallies that eventually fizzled and led to new lows.
The stock market's latest "dead cat bounce" may last a while longer, but three factors will, in due course, lead it to turn south again.
First, macroeconomic indicators will be worse than expected, with growth failing to recover as fast the consensus expects.
Second, the profits and earnings of corporations and financial institutions will not rebound as fast as the consensus predicts, as weak economic growth, deflationary pressures, and surging defaults on corporate bonds will limit firms' pricing power and keep profit margins low.
Third, financial shocks will be worse than expected. At some point, investors will realize that bank losses are massive, and that some banks are insolvent.
Deleveraging by highly leveraged firms - such as hedge funds - will lead them to sell illiquid assets in illiquid markets.
So, while this latest bear-market rally may continue for a bit longer, renewed downward pressure on stocks and other risky assets is inevitable.
To be sure, much more aggressive policy action (massive and unconventional monetary easing, larger fiscal-stimulus packages, bailouts of financial firms, individual mortgage-debt relief, and increased financial support for troubled emerging markets) in many countries in the last few months has reduced the risk of a near depression.
That outcome seemed highly likely six months ago, when global financial markets nearly collapsed.
There may be light at the end of the tunnel - no depression and financial meltdown.
But economic recovery will take longer than expected.
(The author is professor of economics at the Stern School of Business, New York University. The views are his own. Copyright: Project Syndicate, 2009. www.project-syndicate.org.)
Investors are talking of a "green shoot" of recovery and of positive "second derivatives of economic activity" (continuing economic contraction is the first, negative, derivative, but the slower rate suggests that the bottom is near).
As a result, stock markets have started to rally in the US and around the world. Markets seem to believe that there is light at the end of the tunnel for the economy and for the battered profits of corporations and financial firms.
This consensus optimism is not supported by the facts.
I expect that while the rate of US contraction will slow from -6 percent in the last two quarters, US growth will still be negative (around -1.5 to -2 percent) in the second half of the year (compared to the bullish consensus of 2 percent).
Moreover, growth next year will be so weak (0.5 to 1 percent, as opposed to the consensus of 2 percent or more) and unemployment so high (above 10 percent) that it will still feel like a recession.
In the euro zone and Japan, the outlook for 2009 and 2010 is even worse, with growth close to zero even next year.
China will have a more rapid recovery later this year, but growth is likely to be below the average of 10 percent over the last decade.
Given this weak outlook for the major economies, losses by banks and other financial institutions will continue to grow.
My latest estimates are US$3.6 trillion in losses for loans and securities issued by US institutions, and US$1 trillion for the rest of the world.
Many US and foreign banks are effectively insolvent and will have to be taken over by governments. The credit crunch will last much longer if we keep zombie banks alive despite their massive and continuing losses.
Given this outlook for the real economy and financial institutions, the latest rally in US and global stock markets has to be interpreted as a bear-market rally.
Economists usually joke that the stock market has predicted 12 out of the last nine recessions, as markets often fall sharply without an ensuing recession.
But, in the last two years, the stock market has predicted six out of the last zero economic recoveries - that is, six bear-market rallies that eventually fizzled and led to new lows.
The stock market's latest "dead cat bounce" may last a while longer, but three factors will, in due course, lead it to turn south again.
First, macroeconomic indicators will be worse than expected, with growth failing to recover as fast the consensus expects.
Second, the profits and earnings of corporations and financial institutions will not rebound as fast as the consensus predicts, as weak economic growth, deflationary pressures, and surging defaults on corporate bonds will limit firms' pricing power and keep profit margins low.
Third, financial shocks will be worse than expected. At some point, investors will realize that bank losses are massive, and that some banks are insolvent.
Deleveraging by highly leveraged firms - such as hedge funds - will lead them to sell illiquid assets in illiquid markets.
So, while this latest bear-market rally may continue for a bit longer, renewed downward pressure on stocks and other risky assets is inevitable.
To be sure, much more aggressive policy action (massive and unconventional monetary easing, larger fiscal-stimulus packages, bailouts of financial firms, individual mortgage-debt relief, and increased financial support for troubled emerging markets) in many countries in the last few months has reduced the risk of a near depression.
That outcome seemed highly likely six months ago, when global financial markets nearly collapsed.
There may be light at the end of the tunnel - no depression and financial meltdown.
But economic recovery will take longer than expected.
(The author is professor of economics at the Stern School of Business, New York University. The views are his own. Copyright: Project Syndicate, 2009. www.project-syndicate.org.)
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