Bad times are coming, according to Nouriel Roubini, although they may be a year or two away.
The New York University professor of economics is worth listening to since he called the U.S. housing bust and global financial crisis not only exactly right but in time to do something about it. In 2006, for example, he told the International Monetary Fund that the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence, and, ultimately, a deep recession.
Now the problem is what Roubini called “the mother of all carry trades” in a speech delivered via satellite to a conference in South Africa. “The risk is that we are planting the seeds of the next financial crisis.”
With U.S. interest rates near 0% and the U.S. dollar falling in value, every speculator and trader in the world who can is taking out low cost dollar-denominated loans and putting the cash into commodities, commodity stocks, emerging market currencies, emerging market stocks, and real estate.
That borrowed cash raises asset prices, earning profits for traders, and encouraging yet more traders to borrow and get in on the game.
The result, Roubini said, is that the world is seeing the creation of another round of insupportable asset bubbles. “Everybody is playing the same game and this game is becoming dangerous.”
One of the problems with a trade that everybody has on is that it’s incredibly difficult to exit. Exactly who do you sell to when everybody wants to sell? In this situation, as we’ve learned in th curent crisis, prices fall off a cliff and some markets cease to function in an absence of buyers.
You can see the building bubbles reflected in the prices of stocks and commodities since the March 9, 2009 low. The MSCI World Index of developed market stocks is up 65% as of October 26 from that low. The MSCI Emerging Markets Index is up 96%. The Reuters/Jefferies CRB Index of 19 commodities is up 32%.
I flagged this danger in my October 14 post on the worries facing investors (https://jubakpicks.com/2009/10/14/know-what-to-worry-about-and-when-if-you-dont-want-to-get-spooked-out-of-a-rally-or-get-killed-in-a-correction/ ) in the months and year ahead. The most likely event to prick these asset bubbles is the one Roubini mentioned in his speech and I noted in my post: When the U.S. Federal Reserve starts to talk about raising interest rates, traders will start to unwind their bets in order to pay down their dollar loans before the dollar starts to rise in price.
We’ve got a way to go before that happens. The Federal Reserve isn’t likely to start talking about raising rates (let alone actually doing it) until mid-2010 at the earliest, in my opinion.
Roubini puts the bust further out: The asset bubble bust may not occur for another year or two, he told the conference, and in the meantime a wave of money from the carry trade will keep inflating the bubbles.
Which, of course, will make any bust in 2010 or 2011 just that much more painful.
I think you have to own some commodity investments (oil, fertilizer, metals) if you want to survive a long term decline in the relative value of the US dollar. This decline is going to continue for quite some time due to our sense of entitlement and our unwillingness to cut anything significant from the federal budget at the same time that we keep adding more and more expensive programs. How do you avoid getting killed during the sharp corrections that always occur in these markets? One way is simple selling discipline. Take a percentage of your profits off the table at fixed intervals on the way up but never sell it all. You may leave some profit on the table but you will feel good about getting the most out of at least some of your position. When a sharp correction occurs average back in. From some of the comments I am seeing a lot of people are waiting too long too sell out of a position whether it is a loser or a winner. If you never take a profit you will never actually have one. There are very very few long term buy and hold stocks no matter what the “professionals” tell you.
If you are an investor as opposed to a trader – then Roubini’s perspective means there is absolutely no incentive in the next 18 months to do anything except sell into rallies and accumulate cash and wait until the rate hikes begin.
Everyone is anticipating recovery. They don’t want to miss-out. That’s a formula for doing nothing. Ask yourself this question – has Japan ever recovered from its asset bubble? Why do you think we can create a probable solution faster? On top of that, volatility in world markets means technical indicators are about as useful as rolling dice at the Las Vegas Sands in Macao.
I have been moving much of my portfolio into hi yield corporate bonds and preferred stock but staying away from financials with the exception of the National Bankof Greece (9.1% div) and ING – about a 10% yield at the current price. Does anyone have any feedback on this stratagy?
Obama listens to Larry Summers. It’s going to get worse…
I’m with you mathruchandnani. I don’t know what to do. I’ve managed to claw my way back to almost even buying foreign and commodity type stocks. Jim – I’m not convinced that the dollar is oversold. Obama ignores Paul Volcker and listens to Greenspan. Obama is going to continue to make the wrong moves that prolong the recession and weaken the dollar.
I suppose the message for the cynical is “keep floating on this bubble, it’s not likely to pop until 2H10.”
Recently it has felt that buy and hold has went to the way side, and I’ve also put in close stops to the downside (used to keep losses at near 8%, but moved that up to 6).. I’ve been short the market the last week, and have been playing some swings with SPXU / UPRO quite successfully.
I’m also short the 20yr via TBT and short with TMV.
I was about 80 / 20 on the rally up (Stock / Cash) but am now 50 / 50 with 50% of that 50 being Short..
It’s a crazy market.. do your own due diligence.. but be careful, the market is skittish, and lots of people actually going into treasuries today..
so what do you do now. Can someone knowledable tell me if I should get out of stocks?