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Bears Test Market Apocalypse With Notoriety Roubini Knows Well
2010-06-10 23:01:51.940 GMT
By Jessica Silver-Greenberg
June 11 (Bloomberg) -- During the great credit party that
raged around the world for the five years leading up to 2008, a
few economists and investors avoided the punch bowl. They stood
in the corner, muttering about how it would all end with the
hangover of the century. They were outcasts.
“I was lambasted and ridiculed as an idiot,” said Michael
Panzner, a stockbroker and author who began calling the collapse
in 2005. “Like one of those guys holding a cardboard sign
predicting apocalypse.”
By the time Lehman Brothers Holdings Inc. failed and
worldwide markets plunged, Panzner had published a book called
“Financial Armageddon: Protect Your Future from Economic
Collapse” and would follow up with “When Giants Fall: An
Economic Roadmap for the End of the American Era.”
As the economy contracted, the reputation of doomsayers
soared, Bloomberg Businessweek reported in its June 14 issue.
Suddenly they were the party animals. Gary Shilling, a veteran
investment guru based in New Jersey, was feted for nailing all
13 of his investment guidelines for 2008, most of which involved
shorting banks and housing stocks.
Meredith Whitney, who shocked her peers with a devastating
report on Citigroup Inc. when most investors judged it sound,
started her own firm on the basis of her newfound celebrity. A
New York University professor named Nouriel Roubini became a
headliner on the international conference circuit, attracting
actual groupies.
The Turnaround
Then the ground started to shift. For most of the last year
the U.S. economy has been inching toward recovery. While far
from sunny, 2009 didn’t bring with it tent cities or breadlines,
as some of the bears said it would.
The U.S. Labor Department reported that payrolls grew by
431,000 in May, the fifth consecutive month of gains. In April,
sales at U.S. retailers gained 8.8 percent from the same month
last year. Investment banks beat analysts’ earnings estimates
and the markets gained 80 percent in just over a year.
Consumer confidence rebounded and gross domestic product is
growing at about 3 percent. Gradually the bears lost airtime,
and most -- although not Roubini -- slipped from view. Now, as
the markets show fresh signs of stress, much of it emanating
from the sovereign debt crisis in Europe, the spotlight is
swinging back their way. Most of the bears have changed their
outlooks only marginally, if at all.
Biggest Bears
Which raises the question: Is their pessimism a mark of
brave, nonconformist thinking, or has their negativity become a
kind of crisis shtick -- contrariness for the sake of notoriety?
Bloomberg Businessweek assembled the most prominent bears from
2008, traced the development of their outlooks, and assessed
where they see the economy going from here.
As early as 2004, Roubini, 52, predicted an imminent
recession caused by widening U.S. trade deficits and rising oil
prices and interest rates. It didn’t come. In 2005 he again
called for a recession. It didn’t come. His revised prediction
was for 2006. That year, he spoke at an International Monetary
Fund meeting and predicted the coming housing bust, saying the
“United States was likely to face a once-in-a-lifetime housing
bust ... and ultimately a deep recession.”
After Roubini’s predictions finally came true and the world
staggered into 2009, he said oil prices would remain low through
the year, sinking to between $30 and $40 a barrel, and that the
Standard & Poor’s 500 Index would dip to 600.
Wrong Way
Neither happened. Oil jumped to $70 a barrel in November
and the S&P 500 hit bottom at 676, then blew past 1,000. Still,
Roubini sees doom almost everywhere, including Brazil, one of
the world’s best-performing economies over the past year. He
diagnosed it as at risk of “overheating” at an event last
month in São Paulo.
Back in the U.S., where he recently celebrated the
publication of “Crisis Economics: A Crash Course in the Future
of Finance” with a party hosted by Ken Griffin of Citadel
Investment Group LLC, he remains skeptical of the banks, as well
as the debts run up by the government to resuscitate them.
In a May 11 interview with Charlie Rose, Roubini noted the
government had picked up roughly $40 billion of soured debt from
now-deceased Bear Stearns Cos. and said “this buildup of public
debt is something I worry about.” He called the bailout of
American International Group Inc. “a mistake,” and when
prodded by Rose said that “zero interest rates are leading to
an asset bubble globally.”
In the first chapter of “Crisis Economics,” Roubini
argues that financial panics are predictable and not merely
random events. In discussing this with Rose, he said: “When you
live in a bubble, everyone is delusional.” Present company
excepted, naturally.
Outside Views
Roubini is the leading brand name in the community of
market prognosticators who pride themselves on being outside the
Wall Street establishment. This independence, they say, allows
them to see the fictions that people inside the system are blind
to. Compared with the others, Roubini’s forecast is mild. Most
tend to view another recession as a near certainty, with the
second leg more brutal and destabilizing than the first.
One of the most famous of these outsiders is Robert
Prechter. In the 1970s he revived an old system of measuring
investor psychology called the Elliott Wave Principle and used
it to advise subscribers of his investment newsletter on Oct. 5,
1987, that they liquidate their stock holdings. Two weeks later,
the market crashed.
Too Late
Prechter was hailed as a genius -- though the label didn’t
stick. In 1993, the Wall Street Journal ran a page-one story
headlined “Robert Prechter Sees His 3,600 on the Dow -- But 6
Years Late.” He stayed pessimistic through the 1990s, and in
2002 said the Dow Jones Industrial Average would fall below
1,000. It surged 25 percent the following year and kept going up
until 2007.
According to Prechter, 61, the market’s failure to crash as
he predicted only set it up for more devastating blows down the
road -- which could be right now. Last March he correctly called
the market bottom and predicted a rally. That has now run its
course. The S&P 500, he says, will dip below its March 2009 low.
“From a peak in 2010, the stock market should fall for six
years,” he says. Although his pessimism remains the same, the
basis of it has changed. This time around it’s rooted in the
actions of governments. “Government is acting like the last
drunk at the party. Government is spending at an unprecedented
rate, regulating the minutest areas of our lives, and strutting
around as if it’s solving problems as it creates them.”
More Losses
Coming up next, according to Prechter? Another crisis in
real estate and stocks. “The next crisis will encompass markets
that are already off their highs: stocks, commodities, and real
estate. But it will also extend to areas that have so far sailed
through, namely corporate and municipal bonds, asset-backed
bonds, and even many sovereign government bonds.”
Money manager Peter Schiff was born an outsider. His father
is a famous tax objector who is serving a lengthy sentence in an
Indiana prison. Like Panzner, Schiff had a book on the shelves,
“Crash Proof: How to Profit from the Coming Economic
Collapse,” when the financial panic struck. His thesis, which
revolved around the structural flaws of the U.S. economy as well
as what he saw as the inevitable collapse of the U.S. housing
market, proved to be half correct.
The second part of it, that investors could protect
themselves by plowing their cash into foreign stocks, didn’t pan
out. Schiff, 47, became a fixture on business television,
fanning the flames with bold pronouncements that economic
conditions were actually worse than people thought. Now he’s
attempting to leverage his notoriety into a run for the seat
being vacated by Democratic Senator Chris Dodd of Connecticut.
‘Dead Wrong’
Monetary policy, or what he sees as the colossal
mismanagement of it by the Federal Reserve, is the centerpiece
of his fledgling campaign. “Everything the government has done
has been dead wrong,” he says. “They have compounded the
underlying problems in our economy.”
On the campaign trail, Schiff gets worked up about the
government’s mishandling of the economy, especially the quasi-
public mortgage agencies Fannie Mae and Freddie Mac that have
consumed $125 billion in aid so far. According to Schiff, the
Obama administration’s decision to save companies deemed too big
to fail exacerbated the problems facing the country because it
created an unmanageable federal deficit.
“We bought some time, but the cost of the borrowed time is
a great recession,” he says. “Those who think otherwise were
just fooled by phony economic growth produced by stimulus
funds.” Schiff believes that frivolous personal spending has
corrupted the U.S. economy and that it must be reformed by
reconstituting the manufacturing sector.
Obama Recession
“We have to spend less and we have to invest more because
there is going to be a depression that spans the Obama
presidency,” he says. “And it has the potential to be really
horrific.” When asked about immigration, on the campaign trail
-- where he barely has made a dent against former World
Wrestling Entertainment Inc. executive Linda McMahon in the
Republican primary -- Schiff answers that he’s more worried
about the opposite: “Ambitious, smart people are going to want
to leave the country. No one is going to want to stay here.”
Like Schiff, Panzner is an evangelist on the evils of debt,
and finds confirmation of his views in the Moody’s Investors
Service statement in March that the U.S. government was at risk
of losing its pristine AAA credit rating and might have to so
drastically alter fiscal and monetary policy that it “will test
social cohesion.” Also like Schiff, he faults the government
for not forcing Americans to reckon with the real consequences
of the recession.
Austerity Measures
“What makes this so much worse is that the government has
been assuring people that everything will be OK and that a
solution to this didn’t require pain,” he says. “That’s just
not true.” Without a period of austerity, he argues, the
economy will never properly recover. “So yeah, I am a perma-
bear,” he says proudly. “Because none of the fundamental
problems have been addressed, the government is still enabling
companies to make risky loans, and even some of the same kinds
of loans that helped contribute to the downturn in the first
place.”
Among the outsiders, Nassim Nicholas Taleb, 49, is the
polemicist-in-chief. Famed for hectoring audiences of bankers
(who invite him to speak and pay his five-figure speaker fees)
and aggressively countering negative reviews of his work, Taleb
gained a cult following when he published “Fooled by
Randomness: The Hidden Role of Chance in the Markets and in
Life” in 2001. It detailed how Wall Street deludes itself and
investors with predictive models that regularly get blown apart
by reality.
Risen Star
In 2002, Malcolm Gladwell profiled Taleb in The New Yorker,
focusing on his investment in cheap, out-of-the-money options,
betting that the market underestimated the likelihood of
crashes. Then he shot to stardom with the publication of “The
Black Swan: The Impact of the Highly Improbable” in May 2007,
which extended his critique of risk management on Wall Street.
Taleb argued that the models used to measure and contain
risk were inherently flawed because they did not -- and could
not -- take into account the existence of black swans, or
unpredictable, potentially disastrous events. Taleb’s timing was
exquisite: The book hit shelves just months before banks started
announcing billion-dollar writedowns on their subprime holdings.
“The Black Swan” hovered at the top of the New York Times
best-seller list, was translated into more than 27 languages,
and won Taleb an appointment as distinguished professor of risk
engineering at New York University, a custom-fit title he’s
quite proud of. “It’s the highest title that they bestow in the
department,” he says.
More to Come
To Taleb, the worldwide response to the 2008 crash has only
made the economy more vulnerable to black swans. “The same
analysis I made in 2006 holds stronger today with even more
force,” he says. “It’s worse on both fronts. We have a
swelling of contingent liabilities and hidden risk. We may be,
cosmetically, growing things, but our liabilities and our debt
are growing, too. I am expecting that things will only get worse
because we wasted too much time not repairing the system. We are
in an unprecedented time.”
For pure bombast, Taleb’s only rival is Marc Faber, who
publishes the “Gloom, Doom and Boom Report” from his home in
Hong Kong. Since 2002 the 64-year-old, Zurich-born economist has
been predicting that the dollar would plummet in value, and
since 2005 that an economic meltdown was about to hit the U.S.
Faber now expects a sovereign-default domino effect, and
he’s not much rosier on China, saying in a Bloomberg Television
interview that its economy might crash within the year. As for
the S&P 500, he expects it to drop as much as 15 percent in the
next six months.
Gloom, Doom
How will we cope with all this turmoil? In the June 2008
issue of “Gloom, Doom and Boom,” he recommended that Americans
can help themselves by partaking in “prostitutes and beer,”
because they are “the only products still produced in the
U.S.”
When he last worked on Wall Street a quarter century ago,
Gary Shilling, now 73, had a hard time being the bull his bosses
wanted him to be. He believed the U.S. economy was in a long-
term deflationary period and that bonds would prove to be a
better bet than equities.
The last two years haven’t shaken his certainty. He
believes American consumers can’t avoid a fundamental downshift
in their spending habits. “It’s not about perception at all,”
says Shilling, who was the chief economist at Merrill Lynch &
Co. and has published an investment newsletter for the past 25
years. “I am a realist.”
Bee Keeper
For someone who rejects the title of bear, Shilling has an
unfortunate hobby: He keeps bees and frequently hands out jars
of honey to friends -- gifts far sweeter than his outlook on the
global economy. After his stunning success in 2008, he kept his
investment advice unchanged heading into 2009, bluntly
predicting “the worst global financial crisis and deepest world
worldwide recession since the 1930s will continue throughout
2009,” which Business Insider editors translated succinctly
into “We are still screwed.”
He forecast a continued boom in U.S. Treasuries, as capital
worldwide sought safety, and predicted that the S&P 500 would
end the year between 500 and 600 points. Not quite. It turned
out to be almost double that, with Treasuries performing worse
than the junk he warned investors away from.
Shilling holds to the view that recovery is a mirage
whipped up by government stimulus, that the economy is held in
check by declining home prices and contracting credit. Even
though consumers had more personal income in March, according to
the U.S. Commerce Department, spending patterns didn’t follow
suit. The personal savings rate has been increasing, reaching
3.6 percent of disposable income in April.
‘Off a Cliff’
“With the decline of housing prices, consumers went off a
cliff,” he says. “They just don’t have the kind of spending
power or desire that they did in the past.” While many have
focused on how the European debt crisis will affect U.S. trade
with the continent, Shilling sees it reigniting the banking
crisis, which he contends has been papered over.
“U.S. banks have $1.5 trillion in exposure to the euro
zone and the U.K.,” he says. “That’s 48 percent of their total
exposure, so the risk to the U.S. is predominately financial.”
Shilling doesn’t mind that 2009 returned him to the outskirts of
popular opinion. Consensus around his views is bad for business.
For his advice to be worthwhile to his newsletter subscribers,
he says, “it’s got to be something the herd doesn’t see.”
For Stephen Roach, traveling outside the pack is
professionally precarious. Unlike most of the 2008 bears, he
works within the establishment, serving until recently as
chairman of Morgan Stanley Asia. He is now returning to New
York, where he will split his time between Morgan Stanley and
teaching at the Yale School of Management.
Wall Street Stakes
“It’s never easy, especially when you are working on Wall
Street, especially when there is an awful lot at stake for the
good times to continue,” he says. “It’s one thing to be an
academic who can make points purely for academic purposes. It’s
energizing to think and rethink your position.”
Roach, 64, has been warning Wall Street of imminent pain
since 2004, based on his conviction that runaway housing prices
were feeding an unsustainable boom in consumer spending. When he
moved to Hong Kong in 2007, he focused his consternation on
Asia, arguing that for the world economy to achieve stability,
people there would have to start spending more and American
consumers would have to start saving more.
Although he concedes that “the world is definitely in
better shape than it was a year and a half ago,” he believes,
like Shilling, that the European debt crisis will smack the U.S.
hard.
Recession Risk
“No one wants to talk about the possibility of a double-
dip recession,” he says, “but it’s very much there.” The 750
billion euro aid package hammered together by the European Union
“is not going to be enough,” he says. “Multiple contractions
will inevitably follow.”
Monetary policy is a particular bugaboo for Roach because
he believes that the preponderance of easy money led to the
bubbles and bursts. “Fiscal and monetary policy makers haven’t
given me any confidence that they have adopted or even thought
deeply about an exit strategy from zero interest rates and
massive deficits.”
Like Roach, Meredith Whitney made her dire predictions from
within the financial establishment, which is one reason they
caused such a stir. As an analyst for Oppenheimer, Whitney, 40,
put out a research report with the seemingly innocuous title,
“Is Citigroup’s Dividend Safe? Downgrading Stock Due to Capital
Concerns.” The conclusion, however, was jarring: Unless
Citigroup raised $30 billion by chopping its dividend or quickly
unloading assets, Whitney opined, it would surely fail.
Citigroup’s shares promptly swooned, and within days the bank’s
chief executive officer, Chuck Prince, resigned.
Bank Rally
Whitney left Oppenheimer and launched Meredith Whitney
Advisory Group in February 2009, where she continued to predict
trouble in the banking sector. The market judged otherwise. In
the spring of 2009, as the banking sector rallied strongly off
its historic lows, Whitney made no calls as unambiguously
prescient as her Citigroup analysis. She was skeptical of the
government efforts to revive the banks and maintained her
bearish stance. She remains extremely cautious, contending that
U.S. lenders face a tough second quarter because of rising
capital requirements that will undercut their profitability.
“A vast majority of last year’s profits for the banks were
government-induced,” she told the Bloomberg Markets Global
Hedge Fund and Investor Summit in May. “The government is
putting a lifeguard on duty so that people will play in the
pool.” Still, she indicated that if prices fell further, she
might dip a toe in the water and fish out some bank stocks. As
for the housing market, “I’m steadfast in my belief that
there’s going to be a double dip,” she says.
Cool, Calm
David Rosenberg, chief economist at Gluskin Sheff, has been
as consistently bearish as Whitney, though he’s less certain of
a second recession. His is the cool, calm, and collected voice
of doom, cautioning restraint and a dispassionate assessment of
the markets. In his former job as chief North American economist
at Merrill Lynch, Rosenberg was wary of the boom surrounding
him. In 2006 he circulated a research note called “Reassessing
Hard Landing Risks” in which he argued that “you can’t blindly
look at a 4.7 percent unemployment rate and draw the conclusion
that the labor market is tight enough to generate accelerating
wage growth when there are as many as three potential job
seekers out there for every available position.”
Bottom 10
As the subprime mortgage market contagion spread into 2008,
Rosenberg estimated that the economy would barely notch any real
growth, pegging his estimate at 1.6 percent. By the end of
January, he’d already cut his forecast in half. He has long been
more negative than most. In a 2008 Bloomberg survey of 55
forecasters, he ended up in the bottom 10 for his predictions on
GDP, inflation, unemployment and the federal interest rate for
2006 to the middle half of 2008.
Rosenberg has spent most of the past year casting doubt on
the market rally, which he saw as a product of government
stimulus and false hope. “Still no sign of organic private
sector growth,” he wrote on Feb. 3, 2010.
For now, he says, investors should understand that a
“corrective phase is completely normal.” The movement of the
markets so far, he says, is pointing toward some “visible
growth moderation toward the end of the year, but not a double-
dip recession.”
‘Extremely Fragile’
Rosenberg, 49, hasn’t yet settled on the magnitude of the
contraction. For now he’s focused on the stability of the growth
we’ve seen. “Mortgage applications for new purchases are down
to levels we haven’t seen since 1997 and there is a downdraft of
jobs, so the recoveries are extremely fragile.” But he allows
that economic data don’t tell the whole story. “The problem, of
course, is essentially one of human emotion,” he says. “We are
essentially somewhere between Armageddon and Nirvana.”
Even the most sophisticated people have difficulty
switching world views, especially after theirs have been
affirmed. “Outlooks tend to be fairly deeply ingrained,” says
Julie K. Norem, an associate professor of psychology at
Wellesley College. “Pessimists will pay attention to
information that is punishing, not rewarding, and that’s their
fundamental outlook.”
Some bears understand that -- and are trying hard to
change. Take Jeremy Grantham, the 71-year-old head of investment
firm Grantham Mayo Van Otterloo, who trotted out his negative
predictions to much public ridicule at the 2006 meeting of the
IMF in Davos. While he has been predominately down on the
economy since 1997, he has to balance his negative view against
the demands of his day job, which is about making money for
clients. During a January speech to investment advisers, he
reflected on the price of his past bearishness: “We lost
business like it was going out of style.”
No Disaster
While he’s certainly not a bull this time around, Grantham
has taken a gentler tone on the U.S. economy’s future. He says
it won’t be disastrous and is advising his clients to pick up
stocks of U.S. companies with little debt and stable returns,
which will beat out other large-cap firms. His latest
newsletter, called “Playing with Fire (A Possible Race to Old
Highs),” expresses both hostility to what he sees as the
Federal Reserve’s careless monetary policy and an acknowledgment
of the investment opportunities out there. Fed Chairman Ben S.
Bernanke, Grantham writes, “is begging us to speculate.”
James Grant, the 63-year-old publisher of Grant’s Interest
Rate Observer, also refuses to stick to pessimism merely for
consistency’s sake. Grant’s reputation also soared in the 1987
crash -- and fell during the two major bull markets since. The
Wall Street Journal lampooned him in 1996 for being “a foolish
idiot who was way behind the times,” he says.
Conviction of Youth
“That’s what I remember most about the errors of my
impetuous youth, having an unshakable conviction that the credit
difficulties were never really resolved, therefore the stock
market was on shaky ground. It makes me very humble about what
one can know about the future, and makes me less dogmatic.”
Where not so long ago he saw inflated prices everywhere, he
is now enthusiastic about undervalued assets, recently advising
his newsletter clients to buy the despised stock of Yellow Pages
publishers and steering them away from bonds (“bundles of
promises to repay debt with valueless currency,” he called
them). Grant is actually optimistic about the economy -- or at
least optimistic for him.
“I am a skeptic who is trying to be less the prisoner of
his own neurological makeup,” he says, before citing historical
precedent. “There is a well-documented tendency for steep and
ugly recessions to give rise not to weak and profitless
recoveries, but to strong ones.”
Trinity Church
Peering out his Manhattan office at a picture-perfect view
of 300-year-old Trinity Church, Grant continued: “We observed
this in the recessions of 1991 and 2001, which were meek and
mild, and so were the corresponding recoveries.” The deep
recession of the early 1980s, on the other hand, led to a
spectacular recovery.
Based on that, Grant believes the rebound from this
recession will be job-rich and strong, a position he has stuck
to for nine months now. His bear suit has been sent out to the
cleaners, and he doesn’t know when it’s coming back.
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--Editor: Hugo Lindgren
To contact the reporter on this story:
Jessica Silver-Greenberg in New York +1-212-617-3767 or
[email protected].
To contact the editor responsible for this story:
Hugo Lindgren at +1-212-617-2357 or
[email protected].