Nouriel Roubini Should Stick to Economics, not Market Forecasting

In Roubini Says Global Stocks May Correct as Growth Disappoints, Bloomberg.com continues to publicize the market views of a top-tier economist who has built a large consulting business. The article begins:

A global rally in stocks may end in the second half of the year amid a muted recovery in the world’s largest economies and as deflationary pressures limit gains in corporate earnings, Nouriel Roubini said.

Failure to restrain asset-price bubbles in emerging markets, fueled by loose monetary policies in the U.S. and around the world, may also cause an “unraveling and a significant correction of asset prices which will be damaging to global and regional economic growth,” Roubini, the Harvard- schooled New York University professor who in 2006 foresaw the financial crisis, said in Hong Kong today.

At this point, the Roubini outlook as expressed in the article are quite mainstream.

Because they are mainstream, it is unclear whether even if events occur as he predicts whether markets are discounting this and will look forward even as a growth slowdown occurs.

What is most important in looking at markets is spying relative over- and under-valuation. A classic example involves March 2000. The NASDAQ peaked around 5100, having doubled in 1999 and gone up a bit farther in the new year. Fundamental measures of market overvaluation were at record levels, surpassing those of 1929.

Yet there were a great many industry groups that bottomed exactly when the averages popped. These groups were diverse and included homebuilders, HMOs, basic industry, and other out of favor groups. By mid-2002, if memory serves me well, the Russell 2000 was hitting record levels even as the averages were floundering. By the time the market his its double bottom in early 2003, many stocks had moved a great deal.

Toll Brothers, for example, bottomed in March 2000 around 4 and hit 15 little over 2 years later, ending 2003 at 20 (about where it trades today).

What had really happened was that the average stock, rather than the large cap stocks and the tech sector, topped out during the Asian contagion that began in 1997 and rolled on through 1998; it is those stocks that kept bleeding support and got grossly undervalued relative to the popular stuff.

It appears to me that a milder version of that has now occurred. One can look through Value Line and find company after company that is way off its lows, has a poor long-term chart, relatively weak financial strength, no dividend payment and none on the way, and a fundamentally rich valuation. One can also find strong companies with fundamental reasonable valuation, rising and record dividends, rising and record sales and earnings, and no reason not to have a reasonable expectation at least mid-to-high single digit returns to shareholders over a 5-10 year history. Relative to the market, they have underperformed the past year, but on a 2-year or 5-year basis, these companies have outperformed the stuff that I believe has moved too much.

These companies have been highlighted many times here. The list does not change much. Some, such as National Presto, have moved a great deal and are no longer cheap. Others, such as Teva, have not moved much. Everest Re, trading around book value, was up yesterday despite the general sell-off.

There are a series of poor investment choices available due to the general inflation of financial assets that Bill Gross wrote about in his December Pimco letter. This will cycle, but living in the present, we know that cash is being trashed but all bonds are increasingly risky given the explosion of debt combined with stagnant incomes.

The warnings of seers such as Nouriel Roubini are part of the chatter, no matter how right they are. Where they are most valuable is when they identify an evolving bubble or a seriously undervalued situation. Right now, the major imbalances - governmental deficits and money-printing are well known (don't sell gold). Unsexy stocks such as Chubb, Everest Re selling at single-digit P/E's and yielding over 2%; discount retailers with low double-digit P/E's and huge free cash flows; Teva and other special situations; and others provide inflation protection yet can do well in a no-growth economy. Over time these financially strong companies that have proven themselves winners over many years tend to continue to be winners.

Nothing in Nouriel Roubini's outlook have any special relevance to my willingness to hold all the above as part of a diversified portfolio. Until he develops more market experience, he would be well advised to stick to getting the economics correct and letting his clients adjust their market expectations accordingly.

Copyright (C) Long Lake LLC 2010

June FOMC Minutes: Bernanke Running for a Second Term

June's FOMC minutes are out. Clearly Ben Bernanke likes his job. He has outlined Barack Obama's wish list for the economy that could provide him a Reagan-like political sweep in 2012. From the FOMC:

Staff Economic Outlook
In the forecast prepared for the June meeting, the staff revised upward its outlook for economic activity during the remainder of 2009 and for 2010. Consumer spending appeared to have stabilized since the start of the year, sales and starts of new homes were flattening out, and the recent declines in capital spending did not look as severe as those that had occurred around the turn of the year. Recent declines in payroll employment and industrial production, while still sizable, were smaller than those registered earlier in 2009. Household wealth was higher, corporate bond rates had fallen, the value of the dollar was lower, the outlook for foreign activity was better, and financial stress appeared to have eased somewhat more than had been anticipated in the staff forecast prepared for the prior FOMC meeting. The projected boost to aggregate demand from these factors more than offset the negative effects of higher oil prices and mortgage rates. The staff projected that real GDP would decline at a substantially slower rate in the second quarter than it had in the first quarter and then increase in the second half of 2009, though less rapidly than potential output. The staff also revised up its projection for the increase in real GDP in 2010, to a pace above the growth rate of potential GDP. As a consequence, the staff projected that the unemployment rate would rise further in 2009 but would edge down in 2010. Meanwhile, the staff forecast for inflation was marked up. Recent readings on core consumer prices had come in a bit higher than expected; in addition, the rise in energy prices, less-favorable import prices, and the absence of any downward movement in inflation expectations led the staff to raise its medium-term inflation outlook. Nonetheless, the low level of resource utilization was projected to result in an appreciable deceleration in core consumer prices through 2010.

Looking ahead to 2011 and 2012, the staff anticipated that financial markets and institutions would continue to recuperate, monetary policy would remain stimulative, fiscal stimulus would be fading, and inflation expectations would be relatively well anchored. Under such conditions, the staff projected that real GDP would expand at a rate well above that of its potential, that the unemployment rate would decline significantly, and that overall and core personal consumption expenditures inflation would stay low.

DoctoRx here. In addition, Bank of America/Merrill Lynch is running ads saying the recession is over. (And, technically, it might be, but the "official" dater of recessions- NBER- will not date the end of the recession until long after it is judged to have ended. That's how hard it is to call the end of a downturn.) Of course, it might already have entered your mind that BofA also wants to please its masters in Washington, just as Dr. Bernanke just might want to please his most important constituent.

It hardly needs repeating that this is a Federal Reserve and a Chairman that did not see the "recession" coming at all, that minimized the effects of a simple "subprime" lending problem, that saw housing as a long-term bulwark of economic strength, and that as recently as the April meeting underestimated the unemployment problem by about 0.5 percentage points.

Going back farther to the Greenspan era, with Bernanke whispering in the Greenspan ear, this is the same Fed that allegedly saw such a risk of deflation in 2003 that a Fed funds rate of 1% was required, along with a painfully slow rise of that rate over several years to a realistic level. All the while inflation was coming to a slow boil.

In other words, the opinion here is that the opinion at FOMC is, charitably, simply one point of view to be considered along with others. Personally, I think that as is the case in my first profession of medicine, it is wiser to follow the advice of those who got things right diagnostically all along. By that analogy, the doctor under whose care a previously-well patient gets very, very sick for an unexpectedly long time may be at the least the wrong doctor. At the other end of the spectrum, the doctor may be what's called a "double 'oh'" = 00, as in Agent 007: License to kill.

Perhaps it's time for Alan Greenspan to come back. 16 years as Chairman; 2 mild recessions that were definitely not depressions or "Great Recessions". Just kidding! But-- I refuse to join with Barry Ritholtz and many others in making AG the main economic villain. There's much to criticize about Alan Greenspan's Fed, but Dr. Bernanke was in charge long before the economic downturn started. He failed to diagnose it properly and failed to prevent a potentially routine virus from morphing into global double pneumonia. Blaming this complication on the prior doctor is unfair. And forecasting a Goldilocks economy in 2012 is amazing.

In any case, the most political and worst Fed Chairman since G. William Miller has produced a masterful political-economic forecast that was worth, at the least, 100 Dow points. Whether this forecast has any additional value remains to be seen.

Copyright (C) Long Lake LLC 2009