Dr. Doom Lightens Up

Nouriel Roubini -- sometimes known as Dr. Doom for the gloomy, though hauntingly accurate, economic forecasts he's made over the past several years -- is using the d word a lot less than he has been recently.

But Roubini, an economics professor at New York University and chairman of his own economic-research firm, is still down on stocks. "I would not invest in global equities much this year," he says. "Stay in cash, liquid assets and government bonds." He says the 27% rally in Standard & Poor's 500-stock index between March 9 and April 27 won't last. "Over the last two years, the stock market has predicted six of the last zero U.S. economic recoveries," he says.

Roubini, who shared his views at the CFA Institute's annual conference in Lake Buena Vista, Fla., is neutral on whether the market will reach new lows. He thinks that the S&P 500 will earn $50 to $60 a share in 2009, and that investors will pay from 10 to 12 times earnings. By that measure the S&P, which closed April 27 at 857.51, could fall to as low as 500. That would be 26% below the market's March 9 low and a whopping 68% below the record high, set on October 9, 2007.

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Deflation, rather than inflation, remains the big concern, he says. Three big-picture forces fuel that view. One, Roubini says, is that global demand is falling, while the global supply of goods has risen sharply over the past few years, mostly because of increased production in emerging markets. Unemployment figures suggest that companies have little reason to raise wages -- anyone with a job these days is happy enough just to have one. And he thinks commodity prices could still fall further. Roubini doesn't think massive government spending will kick up inflation for another two to three years.

The U.S. government's "stress tests" of major banks are little more than a gimmick to instill confidence, rather than a true test of how the banks would fare in a worst-case scenario, Roubini says. The worst-case scenario of the stress tests assumes unemployment reaching 10.3% in 2010. But Roubini says that recent figures on initial jobless claims imply that the U.S. will continue to hemorrhage at least 600,000 jobs each month. So he figures that unemployment will hit 10% this July and reach 11%, maybe even 12%, in 2010.

Roubini thinks many banks reported better-than-expected earnings in the first quarter because they didn't set aside sufficient provisions to cover their loan losses. Similarly, he thinks the relaxing of mark-to-market accounting is nothing better than a short-term illusion. "We're fudging results," he says.

But eventually, he says, we'll have to deal with struggling financial institutions decisively. "You have to take over and clean up the hopeless ones," he says, even if this requires temporary nationalization. "Muddling through is not going to work."

So where are the bright patches in his view? He sees the economy bottoming around early 2010, although "next year will feel like a recession, even if we're technically out of one." He's looking for tepid 0.5% growth in the U.S. in 2010, compared with the consensus view of 2% growth. And Roubini is quick to point out that there's someone even more bearish than he is -- the International Monetary Fund expects 0% growth in the U.S. in 2010.

He no longer thinks the U.S. economy is likely to fall into a depression. He won't say it's a zero-probability event -- after all, he's still Dr. Doom -- but he says we're more likely somewhere in the trough of a U-shaped recession. As for stocks, he says, "certainly today, versus a year ago, equity prices are closer to a bottom" than they were. Coming from Dr. Doom, that's pretty darn sunny.