Roubini Clarifies His ‘Optimism’

The man referred to as ‘Dr. Doom’ has been sounding a little more optimistic in the last 6 weeks, but he explains in this piece why mistaken policy responses will drag out the effects of our current economic crisis for at least a decade.

In short, Roubini argues that we should have ‘delevered’ by converting corporate and consumer debt into equity, but instead we just moved this debt to the government’s balance sheet, increasing total Federal obligations from from 40% to 80% of GDP. The increased debt burden will impose a tax of 3% GDP (around $450 billion), reducing productive public spending and crowding out private investment (and that’s before factoring in the unfunded obligations of Social Security, Medicare and a deteriorating national infrastructure).

You don’t have to read all the way to his fears of a W-shaped recession to convince yourself that canned goods, ammunition and field dressings are still your best-performing assets.

Brown Shoots

  • WSJ on 5/11 – The S&P 500 is priced at 14.7 times trailing 12-month earnings.
  • WSJ today – US consumers spent 0.4% (MTM) less in April.

With all due respect to David Swensen, nobody should be buying S&P index funds these days.

First, a 14.7 PE is over historical average. Second, trailing 12-month earnings should be stronger than forward 12-month earnings. Official unemployment numbers started with 5’s from April through June of 2008. When wallets snapped shut in October the official number was still only 6.5%. We’re over 8.5% now and still climbing. Credit is tighter. Europe and Asia are significantly weaker than they were last year.

And yet we have been reading for the past few weeks that the recession has hit bottom, or that we’ll see recovery by the end of 2009. Don’t believe it.

Every one of the experts quoted in major papers knows more than I do about markets and our economy. Unfortunately, they all really need markets to recover, a conflict which makes their advice nearly useless. They want you to put your money back into the market. They need the layoffs to stop and bonuses to resume. When they tell you they see good news, forget that they’re Phi Beta Kappa folks steeped in market history – see them instead as Dorothy, clicking her heels together and repeating, “There’s no place like home.” Only without the magic slippers.

US consumers were spending somewhere around 103% of their income when the credit markets fell apart. Worse than saving nothing for retirement or a rainy day, they were pulling cash out of their homes for jet-skis, iPods, vacations and boob jobs.

Compare this to 1970, when Americans saved over 8% of their income, before we had massive consumer debt (under water mortgages, credit cards maxed out to keep homes and cars, etc.) to work off. And then imagine that American consumers save not 8%, but 7% for the next few years. Their spending would go from 103% to 93% of income, a 10% swing.

This reasonable (even likely) scenario would knock 7% off the top of US GDP (since consumer spending has been around 70% of US GDP lately). It wouldn’t be just a temporary dip, something we could recover from in a year – it would be the new starting point for the US economy, over $1 trillion lower than 2007’s GDP.

Unemployment, debt and other write-offs only compound the problem. Maybe GDP drops by 10% temporarily, before resuming growth at 91-93% of its 2007 level.

In the Monty Python version a prone S&P 500 would say, “Not live yet!” There may be great deals in the rubble, but don’t buy the market right now.