Liam Dann 's Opinion

Liam Dann is the business editor of the NZ Herald

Liam Dann: Dr Doom tips markets to tumble

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One of the people who foresaw the US mortgage default crisis is picking a sizeable correction for this year.

Nouriel Roubini sees "frothiness" in the markets. Photo / Wikipedia
Nouriel Roubini sees "frothiness" in the markets. Photo / Wikipedia

Well, Dr Doom says the US markets are overheating already. No one likes a party-pooper, especially when the party is just getting started, but given economist Noriel Roubini's track record it would be foolhardy to write him off as just another overly pessimistic grump.

He was dubbed Dr Doom after standing out as one of the few voices last decade to accurately pick the US mortgage default crisis and see that it would precipitate a global financial meltdown.

The good news is that Roubini's not predicting another financial meltdown just yet.

He does feel that Wall St valuations are starting to get get too far ahead of the real recovery and he is picking a sizeable correction this year.

At the weekend he told Bloomberg TV that, while he wouldn't yet call it a bubble, there was "a frothiness" in US markets with price-to-earnings ratios now at levels that couldn't be justified by fundamentals.

It will come as no surprise to anyone following the global business news closely that Roubini doesn't think the exuberance in the tech sector is helping the situation. Already we have seen tech investors pause for thought with some of the most recent market floats not being met with unbridled enthusiasm.

On Friday the tech-heavy Nasdaq Composite Index fell more than 2.5 per cent, with big-name stocks like Facebook, Google and Netflix all falling sharply.

Roubini reckons we'll see the broader market continue to rise in the short term because there is some momentum in the recovery and the US Federal Reserve is not pulling back on stimulatory measures in any great hurry. But he says Wall St could be headed for a sharp correction, of less than 10 per cent, later in the year.

The US markets grew by about 25 per cent last year and that just isn't sustainable given the relatively lukewarm global growth projections.

It would be a dramatic sell-off for a world that is still slowly and steadily stepping its way forward to some sort of solid growth after six years in post-GFC shock.

But it might not be such a bad thing if we want to avoid another boom and bust cycle.

New Zealand's market has also been on a pretty solid bull run over the past couple of years.

In fact, since hitting rock bottom on March 3, 2009, the NZX 50 index is up 112 per cent.

To be fair, our economy has been in better shape, our markets probably overcorrected during the panic in 2008 and 2009.

In New Zealand - if the economic indicators are accurate - we should see good growth in the next couple of years to underpin earnings of our many solid dividend stocks.

But that doesn't mean we wouldn't be vulnerable to a US correction now - particularly since we have tech stocks such as Xero making up a much larger part of the index. And it doesn't mean some valuations can't get ahead of themselves. Things might start to get a bit giddy if the pace of growth here continues unabated.

Markets need the likes of Roubini to carry some clout and give us pause for thought. As the boom progresses it becomes easier and easier to write these guys off as Cassandras or prophets of doom. Certainly that is what happened last time around.

Roubini isn't even particularly apocalyptic about the outlook, he's just sounding a note of caution.

If you want to hear a more dire scenario, just get him started on China or other geopolitical risks like the Crimea. On second thoughts maybe don't.

But pause for thought - it's hard to argue with that if we want to position ourselves for a long, healthy growth phase.

It is vital that the gap between investment market valuations and the realities of the economic recovery doesn't become too large.

There's always a bit of clear air between the two because markets are forward looking and investors want to be ahead of the curve. They can provide a good bellwether for the economic outlook provided they are functioning rationally.

Unfortunately, markets are a reflection of human behaviour and every bit as rational. That is why they are often described as running on either fear or greed. Even if we want to maintain a sensible long-term focus on sustainable growth (and not everyone does), when the herd starts running we have to run too.

This time around it can't hurt to have a plan for avoiding the stampede.

- NZ Herald

Liam Dann

Liam Dann is the business editor of the NZ Herald

Liam Dann is the Business editor of the New Zealand Herald, overseeing all our business content in print and online. He has been a journalist for 20 years, covering business for the last 14 of them. He has also worked in the banking sector in London and travelled extensively. His passion is for Markets and Economics, because they are the engine of the New Zealand economy.

Read more by Liam Dann

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