Nouriel Roubini and the Future of the Stock Market

Most readers are probably familiar with Nouriel Roubini. Roubini was one of the few academic/establishment economists who predicted the credit crisis and the ongoing recession. Liberals especially embraced Roubini because he advocated for strong Keynesian measures to prevent the economy from going into freefall. He's emerged as one of the most influential economists in the world right now, right along with Paul Krugman. One fact that some of you might not know is that, under the Clinton presidency, Roubini was a senior adviser to Timothy Geithner(who is now Treasury Secretary under President Obama).

Roubini has warned his readers that the ongoing stock market rally has a strong possibility of fizzling out and ultimately being nothing more than a "dead cat bounce." Quite simply, the optimism in the market doesn't jive with the weak expectations for earnings growth. Today, Bloomberg has published an article presenting the viewpoint of some Roubini-skeptics. Apparently, a lot of investors genuinely believe we've entered a bull market and they cast doubt upon Roubini's warnings. In fact, according to Bloomberg, some investors might have missed out on "the biggest rally since the 1930s" because they followed Roubini's advice.

When it comes to the stock market's ongong rally, I agree with Roubini. There's a lot of exuberance around the stock market but it's definitely not based on the 2009 and 2010 projections for the U.S. economy, which are still mostly "doom and gloom." Despite all the talk about recovery and "green shoots," our political and financial leaders still haven't pointed to one industry or one economic sector that they expect to significantly grow and be able to drive a recovery over the next few years.

However, the part of the Bloomberg article that I found the most interesting was the following:

Roubini has “done a very good job on the economy,” Birinyi said in an interview Aug. 24. “Our approach is to try to understand the market and not try to do much more than that.”

Laszlo Birinyi is an investment manager (unlike Roubini, who is an analyst and a scholar at New York University) who also correctly predicted the economic collapse, in 2007 (Roubini warned his audience about troubles in the housing market as early as 2005). The article further states:

“Both of them just have a pretty deep understanding of the history of economic and business cycles,” said Eric Teal, who oversees $5 billion as chief investment officer at First Citizens Bank in Raleigh, North Carolina. “Roubini has just had more of an academic background, whereas Birinyi has been much more in the spotlight managing money and working in capital markets.”

I thought these excerpts were quite telling about so much.

What comes through is that investors perceive a divide between "the economy" and "the markets." To some degree, this explains why so many investors were blindsided by the recession. Investors were so focused on understanding the movements and dynamics of the market that they were unable to see the flawed and unsustainable foundations of the economy on which that market was based. Apparently some things dont change.

At the same time, these investors aren't completely wrong in the way they see things. What happens when a company experiencing distress lays off a significant percentage of its workforce? On the one hand, the American economy as a whole suffers because it adds to unemployment and lowers consumption. On the other hand, the economic situaton of that company might genuinely be better because it has reduced costs and has probably come closer to returning to profitability. When this happens on a mass scale, as is happening now, a kind of decoupling between the economy and the markets happens. The market comes to only represent a certain slice of the American economy. Much of the real economy is no longer reflected by the status of the market. The problem is that the media still tries to present the stock market as if it were an accurate measurement of the health of the real economy, which it isn't.

Finally, these comments show just how desperate investors are right now. A small rise in the Dow Jones Industrial Average would have been understandable considering the national economy did just avoid total meltdown. But a small rise isn't the case. The reality is that we're in the midst of one of the steepest rallies since the 1930s, as Bloomberg points out. There are very few safe havens for investors out there. So, when investors saw that the stock market was rallying they were willing to ignore the obvious signs of risk out there (including overt warnings from Roubini and others like him) and they jumped in with the hope of making at least some returns. The desperation of investors tells us more about the state of the economy than the various indices do, in my opinion. We can also see that, as long as there serious doubts about the economy, we can expect some serious volatility in the markets. As a recent commentary by me points out, the Great Depression bore witness to some of the biggest rallies in history.

So when we see something incredibly contradictory like what we see today: Roubini(who is probably the most influential economist in the United States) voicing major concerns over the future of the economy while the stock market rallies and institutional investors declare a bull market ... I think the only thing we can be sure about is that the recession is still far from over and some severely bumpy road (to say the least) still lies ahead.