Roubini Says Stock Rally May End Amid Muted Recovery

A global rally in stocks may end in the second half of the year amid a muted recovery in the world’s largest economies and as deflationary pressures limit gains in corporate earnings, Nouriel Roubini said.

Failure to restrain asset-price bubbles in emerging markets, fueled by loose monetary policies in the U.S. and around the world, may also cause an “unraveling and a significant correction of asset prices which will be damaging to global and regional economic growth,” Roubini, the Harvard- schooled New York University professor who in 2006 foresaw the financial crisis, said in Hong Kong today.

The MSCI World Index has surged 73 percent from last year’s low in March, adding more than $27 trillion to the equity rally as the global economy rebounds from the worst postwar recession. The World Bank, while raising its forecast for global growth in 2010 yesterday, warned that the recovery may lose momentum as stimulus programs wind down and “high” unemployment persists.

“The real economy is gradually recovering but since March, asset prices have gone through the roof,” Roubini said. “If I’m correct, by the second half of the year, there’s going to be a slowdown of growth in U.S., Europe and Japan. That could be the beginning of a market correction because the macroeconomic news is going to surprise on the downside.”

Any decline in commodities may be limited because of demand for raw materials from emerging markets, he said.

Sovereign Risks

Europe and Japan have less room to implement counter- cyclical policies compared to the U.S., making it less likely for those markets to lead the world in the global economic recovery, Roubini said. Sovereign risks in Europe are rising because of persistent budget deficits, and the appreciation of the yen and euro against the U.S. dollar are “making things worse,” he said.

“Even the earnings news is going to surprise on the downside,” Roubini said. Weak economic recovery and deflationary pressures will limit revenue growth as the ability of firms to cut costs runs its course, while losses at U.S. and European financial institutions are going to be larger than those that have been priced by the market amid low growth, a high unemployment rate and still falling home prices, he said.

In the U.S., where the Federal Reserve has pledged to keep interest rates near zero for an “extended period,” the risk of a policy mistake is significant especially in an election year, Roubini said.

Risk of Mistake

“The path of exit is very narrow and the risk of a mistake is significant,” he said, referring to both fiscal and monetary policies.

Economic expansion will be more “robust” in Asia and emerging markets, and parts of the Chinese and Indian economies are showing signs of overheating, Roubini said.

“In emerging markets economies like China and India, inflation is already returning to positive levels because there’s high economic growth and policy boosts,” he said.

China last week unexpectedly raised the proportion of deposits that banks must set aside as reserves as a credit boom threatens to stoke inflation and create asset bubbles. Economies including South Korea and Hong Kong are facing rising asset prices, consumer credit and corporate loans, spurred by record- low interest rates and government stimulus.

The short-term pain to the market caused by the tightening of China’s “super loose” monetary policy is necessary for sustainable growth, Roubini said, adding that consumption rates there are still very low.

Hong Kong should have a managed float for its currency instead of pegging it to the U.S. dollar, as the Fed’s interest- rate policy may not be appropriate for the city, which tracks the U.S. central bank’s rate decisions, Roubini said. There are also pitfalls to pegging the Hong Kong dollar to the yuan, as the loose policies of the U.S. and China aren’t relevant to the city, he said.