The Worst Is Yet To Come
I HAVE been predicting for a while that the most recent bear market
sucker's rally would lose its steam and, like the previous bear market
rallies in the last 18 months, U.S. and global equities prices would
head again toward new lows. Here's why.
As my work and the work of our research team at RGE Monitor predicts
(we will publish, later this week, our 2009 Global Economic Outlook, a
75-page research piece for our clients), this will be the worst U.S.
recession in the last 50 years--and the worst synchronized global
recession in decades.
For a few weeks since late November, equity markets ignored the
onslaught of much-worse-than-expected macro news (and all the news was
really worse than awful) and had a nice 25% bear market sucker's
rally. But the drumbeat of worse-than-expected macro new--and earnings
news, and financial news--has finally taken a toll on the delusional
market belief that the worst was over for financial markets and for
equity markets and that the U.S. and global economy would recover in
the second half of 2009. So equity prices have already reversed more
than half of their most recent bear market rally as the lousy macro
news has finally shocked the wishful thinkers.
Indeed, the retail sales figures just published confirmed that a
shopped-out, savings-less and debt-burdened U.S. consumer is now
faltering as job losses, income losses, falls in home wealth, falls in
equity wealth, high and rising debt and debt-servicing ratios and a
severe credit crunch take a severe toll on the ability of consumers to
spend. And reduction in spending and deleveraging of the U.S. consumer
will take years to rebuild the savings rate of a household sector now
hit by a severe shock to its net worth (as equity and home values fall
while debts have been rising), and shocked in its inability to
generate income as job losses mount and the unemployment rate surges.
Our research at RGE Monitor suggests that the U.S. and global
recession will continue at least until Q4 2009 (a nasty, 24-month,
U-shaped recession) and that the recovery in 2010-'11 will be very
weak, with growth around 1%--well below a potential of 2.75%. And we
cannot rule out that a more severe L-shaped stag-deflation (as in
Japan in the 1990s) will take hold. Indeed, as I have argued, while
the odds of a systemic financial meltdown have been reduced by the
actions of the Group of Seven and other economies, severe
The credit crunch will persist and spread beyond mortgages.
Deleveraging will continue, as thousands of hedge funds--many of which
will go bust--and other leveraged players are forced to sell assets
into illiquid and distressed markets, causing price declines and
driving more insolvent financial institutions out of business. Credit
losses will mount as the recession deepens, and a few emerging-market
economies will certainly experience full-blown financial crisis.
So 2009 will be a painful year of global recession and further
financial stresses, losses and bankruptcies. Currently, the
probability of an L-shaped, stag-deflation is now rising to one-third,
while the probability of a severe U-shaped recession is two-thirds.
Only aggressive, coordinated and effective policy action by both
advanced and emerging-market countries can ensure the global economy
starts to recover, however slowly, in 2010, rather than entering a
more protracted period of economic stagnation.
So while our benchmark scenarios see a severe U-shaped global
recession with very weak growth recovery in 2010, we cannot exclude
the possibility of a worse outcome--i.e. an L-shaped recession that,
in our view, has at least a one-third probability. So the worst is
ahead of us rather than behind us, both for the real economy and for
With my forecast of 2009 earnings per share for S&P 500 firms being in
the $50 to $60 range, and with price-earnings ratios likely to be in
the 10 to 12 range, given a severe global recession, the S&P 500 could
bottom at some point in 2009, at best at a level of 720 and, in a
worse scenario, as low as 500 or 600.
So, the worst is indeed still ahead of us.
Nouriel Roubini, a professor at the Stern Business School at New York
University and chairman of Roubini Global Economics, is a weekly
columnist for Forbes.com.