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There may eventually be light at the end of the tunnel…but not as soon and fast as the bullish consensus makes it: CNBC Squawk Box Interview


Nouriel Roubini | Mar 31, 2009

I was interviewed this morning on CNBC’s Squawk Box on my views on the economy, on the stock market, on the problems with the banks, the Geithner plan and whether there is light at the end of the tunnel.
The full video of this longish interview is available here.
As I pointed out in the interview – consistent with my views for the last several months - the rate of economic contraction will slow from the -6% of Q1 to a figure closer to -2% and next year the economic recovery will be so weak – growth below 1% and unemployment rate peaking at 10% - that it will still feel like a recession even if we may be technically out of it. So, compared to the bullish consensus that sees positive growth at 2% by Q3-Q4 of this year and return to potential growth by 2010 my views are still consistently more bearish than the consensus. Still, compared to the sharp contraction in US and global growth in Q1 of this year (about -6%) the rate of economic contraction will slow down towards -2% for the US and other advanced economies by year end. That is only a mild improvement and still a severe U-shaped recession with a very weak and tentative recovery by 2010.
Let me explain next in more detail my economic outlook and its implications for financial markets:

In the CNBC interview I also pointed out that the stock market has predicted six out of the last zero economic recovery: for the last 18 months we have had six bear market rally and at the beginning of each one of these sucker’s rallies the delusional perma-bulls repeated that this was the beginning of a bull market rally. And for six times these perma-bulls were totally wrong as the bear market rally fizzled and new lows were reached. And for six times I correctly pointed out that these were bear market rallies; but such perma-bulls have no shame in showing up over and over again on CNBC for the last two years and talking their books and being proven wrong over and over again. As I have never been a “perma-bear” in spite of the Dr. Doom nickname I will be the first one to call for the bottom of this severe recession and the bottom of the bear market when I see sustained evidence of robust and consistent economic recovery. I see the latest rally as another bear market rally as over the next few months news will be worse than expected by the consensus: macro news, earnings news, financial news, corporate default news, financial firms insolvency news, etc. Look how wobbly the stock market was yesterday when the expected news that the Big Three are in big trouble led to a 3-4% market fall. Do you listen to Tim Geithner who says that some banks need “large amounts of assistance" and who is now pushing - like Bernanke - for fast track Congressional approval of a law that will allow to takeover systemically important financial institutions and bank holding companies? This market recovery has still very shaky legs and it will until the US and global economic recovery does occur and is more robust and sustained.
The global economic contraction is still very severe: in the Eurozone and Japan there is no evidence of “green shoots” or positive second derivatives; and in the US and China such evidence is still very very weak. So investors and markets are way ahead of actual improvements in economic data. And the idea that stock prices are forward looking and bottom out six to nine months before the end of a recession is incorrect. First, you already had six bear market rallies and stock prices predicted six out of the last zero economic recoveries. Second, in 2001 a short and shallow 8 months recession was over by November but stock prices kept on falling for another 16 months until March of 2003 as the recovery was shallow, as job losses continued until 2003, as deflationary forces controlled pricing power of firms and limited the recovery of earnings, as corporate defaults spiked all the way to 13% of outstanding junk bonds. This time around the recession will be at least 24 months - three times as long and five times deeper in terms of GDP contraction – than the one in 2001. This time the deflationary forces are global, not just in the US and Japan as you got a severe global recession; thus pricing power of the corporate sector and earnings recovery will be weak with such sharp global deflationary pressures. This time you have the worst financial crisis and banking crisis since the Great Depression while in 2001 there was no banking crisis. This time you got the worst housing recession since the Great Depression with home prices still bound to fall another 15-20% for a cumulative fall of 40-45%. This time corporate default rates on junk bonds are predicted by Moody’s to peak at 20%, not the13% of the previous recession. Thus, the idea that a weak US and global recovery with massive deflationary pressures and a severe financial crisis and massive corporate defaults will lead to a robust recovery of earnings and a sharp persistent bull market rally in equities is totally far-fetched.
As I consistently argued before the risk of a L-shaped near-depression will be significantly reduced if aggressive policy actions were to be undertaken. And that risk of near-depression is now lower than 3 months ago – but not gone altogether - as policy makers in the US and globally have now finally gotten religion and taken out the entire range of policy weapons – bazookas, missiles, rockets, artillery – in their armaments and starting to use them more aggressively.
These more aggressive, front-loaded and stronger policies include massive monetary easing and zero policy rates, quantitative easing, unconventional monetary and credit actions to reduce the spread between market rates and government bond yields, significant – if in some cases still insufficient - fiscal policy stimulus, policies to restore credit growth and reduce the credit crunch, policies to clean up toxic assets of banks, policies to recapitalize banks and take over the insolvent ones, policies to reduce the tsunami of foreclosures and reduce the debt servicing and debt burden of distressed households, policies to support emerging market economies under stress, policies of appropriate regulatory forbearance to restore credit and liquidity in financial market (I will discuss these policies in more detail in a forthcoming writing and will assess their tentative advances and improvements and some of their still significant limits).
These policies will not restore positive growth in advanced economies until next year but, as predicted, will reduce the rate of economic contraction to a more moderate pace by the end of 2009. Thus, as we have argued all along the rate of advanced economies economic contraction will slow down from the peak contraction of Q1 (-6%) to a more modest contraction in Q4 (-2%) and a very weak positive growth (0% to 1% in US, Europe and Japan) in 2010 with still sharply rising unemployment rates peaking at 10% in these advanced economies; this will be an improvement compared to the Q4:2008 and Q1:2009 collapse of global economic activity but still a much more bearish scenario than the bullish case of positive and high (2%) growth by Q3-Q4 and return to potential growth by 2010.
So the road ahead is still very very bumpy; the worst for the degree of economic contraction may be by Q2 or Q3 behind us but there will not be any robust and sustained recovery as the damage of the financial and real excesses of the last few years will have lasting effects on actual and potential growth for the US and the global economies; and the burden of trillions of dollars of additional fiscal deficits and debts in advanced and emerging economies will be a drag on actual and potential growth for years to come. But if aggressive policy actions get accelerated after the G20 meeting one can expect a slow and painful process of mending of the US and global economy that will still take a long time – and will be much more slowly than the current bullish consensus – but that will allow us to see the light at the end of the tunnel some time next year, first for the real economies, next for financial markets and finally for the financial system and its wounded institutions.
The light at the end of the tunnel will not be the one of the incoming train wreck if policies become even more robust and aggressive than the current ones; a lot is being done but much more needs to be done. But if the policy actions are stronger and more consistent and better coordinated globally there will be some flickers of light at the end of the tunnel some time in 2010.