Doom and Gloom

He’s at it again! Economist Nouriel Roubini, who's been dubbed Dr. Doom for his gloomy-yet-correct prediction of the 2008 market meltdown, is making headlines again, while promoting his new book "Megathreats". In a series of interviews, he states that “the world economy is lurching toward an unprecedented confluence of economic, financial, and debt crises, following the explosion of deficits, borrowing, and leverage in recent decades. He calls it “the Mother of all Economic Crises!”

We think his reasoning is spot on: “After years of ultra-loose fiscal, monetary, and credit policies and the onset of major negative supply shocks, stagflationary pressures are now putting the squeeze on a massive mountain of public- and private-sector debt.” Roubini casts blame on both the political right and the political left. “Center-right governments have persistently cut taxes without also cutting spending, while center-left governments have spent generously on social programs that aren’t fully funded with sufficiently higher taxes. And tax policies that favor debt over equity, abetted by central banks’ ultra-loose monetary and credit policies, have fueled a spike in borrowing in both the private and public sectors.

In support of his comments about the explosion of debt, Professor Roubini points to some staggering numbers. “Globally, total private- and public-sector debt as a share of GDP rose from 200% in 1999 to 350% in 2021. The ratio is now 420% across advanced economies, and 330% in China. In the United States, it is 420%, which is higher than during the Great Depression and after World War II. We certainly agree that there is a huge debt problem. As we say at the front page of our website, we think the real existential threat is “an over-leveraged economy that is burdened by a huge and growing debt, one which is increasing likely to lead to runaway inflation or to a debilitating deflation.”

So, what will it be – inflation or deflation? Roubini predicts a “stagflationary debt crisis.” He expects the United States will be hit by a “severe recession and a severe debt and financial crisis... As asset bubbles burst, debt-servicing ratios spike, and inflation-adjusted incomes fall across households, corporations, and governments, the economic crisis and the financial crash will feed on each other. Ultimately, when central banks abandon the fight and pivot in the face of the looming economic and financial crash, “nominal and real borrowing costs will surge.”

Famed Swiss investor, Felix Zulauf, who was featured in Barron’s Magazine this week, tends to agree with Nourbini. He is predicting a frightening “roller-coaster market. He points to the largest, sharp decline in monetary aggregates (M2) since World War II, and he believes that the decline in the money supply will pressure corporate profit margins and push earnings estimates much lower. As a result, he thinks “the current stock rally from the October lows is a temporary affair… After a last bounce in January, I think we are in for another big decline”

However, Zulauf believes that a declining economy and falling stock market will force the Federal Reserve to pivot, probably in the second quarter of 2023, and that this will lead to a dramatic, but temporary, bond rally which will only last about six to nine months. The resulting “excess liquidity will flow into the commodity market, and then, inflation will come back from late 2023 onward, and will probably go even higher in ’24, ’25, than it has been in the current cycle... “I think the price of oil goes up in 2024-25 and could easily trade near $200. And that gives you a CPI in 2025 of over 10%. And, of course, bond yields will also move up then, from late ’23 onward in the next cycle.

How is that for gloom and doom? We definitely agree with the predictions for a higher inflation rate, and we think that possibility alone should tend to put a cap on stock market rallies. The markets’ reaction to Tuesday’s better-than-expected consumer price index may be a very good clue for future market action. When the CPI report was released, the stock market roared, and the Dow was up more than 700 points in the blink of an eye, yet it finished only 104 points higher (+0.3%). On the other hand, gold soared over $30 an ounce immediately following the report, and later in the day held much of its strength before finishing 1.85% higher. As an investment, gold typically moves higher in an inflationary environment, while the stock market tends to stay steady at best. Yet on Tuesday, the opposite happened. Gold should have been weaker, given the better news on inflation.

We’ll end this “cheery” article with a comment on another statement by Mr. Zulauf. After stating that the world is dividing into two major blocks – the democratic led by the USA and the autocratic led by China, he declares that “I think that the U.S. made a big mistake by using the U.S. dollar payment systems as a political weapon. Those nations that are not close friends with the U.S. will not store their foreign-exchange reserves in the U.S. dollar anymore.”

Exactly! China has seen how we sanctioned Russia and seized their financial assets, so we believe that China will increasingly not use the dollar as a medium of exchange and will instead pressure its trading partners to use the Yuan. Guess what? If China and its trading partners in Asia are not using the US dollar, they will not need to buy our debt as they have in the past. Who will replace them as buyers as the US continues to spend way more money than it receives in taxes? We think that ultimately means that interest rates will remain much higher than they were in the past, and that will definitely not be good for the stock market.