Dollar-Equity Correlation: Roubini's Got It Wrong (Again)

Readers of this blog have been following the dollar equity correlation since Aug. 21 when I first wrote about it (and to my knowledge, I was the first analyst to publish about it — if you know of others please let me know).

Now the dollar-equity correlation issue is top of the financial blogs, for example this summary of views at FT’s Alphaville blog:

On Monday, none other than Nouriel Roubini, aka Dr. Doom, was making much the same argument in an FT opinion piece. Roubini, though, had dubbed it ‘the mother of all carry trades’ saying:

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius — even if they are just riding a huge bubble financed by a large negative cost of borrowing — as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade — you short the dollar to buy any global risky assets.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe — for now — for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

So will it all end in tears?

Inevitably, according to Roubini, it will — because the dollar simply cannot continue falling to zero. And when the proverbial buck does stop, the effects will lead to nothing less than the biggest coordinated asset bust ever.

Now that does sounds scary.

Roubini, it will be recalled, was the one-trick pony (he did get it right in 2007) who told you to sell bank stocks at the bottom because they were all going to be nationalized. Roubini is an academic economist who doesn’t know a bubble from his — well, never mind. There is NO evidence that the world is borrowing money to buy equities. American assets have gotten cheaper, American companies earning cash flows in foreign currency or producing international tradables are worth more — and that’s it. Now, I think stocks will fall from present levels for a number of reasons, but that is not a collapsing bubble.

Bubbles are created through leverage. There are plenty of worrying applications of leverage, for example, the Private-Public Investment Partnerships that have levered up distressed structured securities a dozen times, and goosed up the price of what used to be called toxic waste. I described this as a mini-bubble toxic waste which contributed to high “trading profits” during the third quarter. My recommendation was to sell the banks. As the mini-bubble burst at the end of October (I reported last week) banks stocks have come down.

Stocks are overpriced, the economy’s weak, and things are bad. That’s not quite the same as the end of the world. If we do get an end-of-the-world scenario, it will be due to some outside the usual range of worries (e..g, Israel strikes Iran’s nuclear program, Iran shuts down the Straits of Hormuz, and oil goes to $300 a barrel).

The trouble with being a consulting economist is that you have to get the world’s attention, and Roubini’s attention-getting act is getting a bit tiresome.

Comments

[traineeinve...:]

Where is the evidence that investors are borrowing more to invest in equities?

A quick check of the HKMA website shows that in Hong Kong at least, total loans have declined this year while deposits have increased. The loan to deposit ratio currently hovers at just above 70%. I'm sure it wouldn't take much effort to dig up similar stats for other markets.

A quick look at data for the larger global financial institutions shows rising liquidity levels. (Actually a regular read of the Financial Times, Asian Wall Street Journal etc will also provide this information.)

Like the word "reform", the word "bubble" is used, and misuded, too often.

Nov 05 01:47 AM

[User 143167:]

There is huge leverage going on this year, not through the brokers marginal accounts, but from the government, and I am not just talking about the US government. Every government is trying to load private debts on their own balance sheet and finance that with new bills printed (which are debts).

As a whole, there is HUGE releveraging in the world now, not deleveraging.

Nov 05 02:28 AM

[Mark Anthony:]

The author:

Well said! I can not agree more!

Roubini is so absurd that he is not even wrong! I don't think he is an academic economist. Any one who makes a living writting research papers in an academic institution must have received plenty of training to understand that he/she should always let data and facts speak for themselve. They would naturally cite numbers and facts, give their data source, give their reasoning, and acknowledge credit where credit is due.

Did Roubini give any number? Cited any data source? Provided any reasoning? Absolutely no. He talks pure fantasy with nothing to back them up. If he is in any other discipline he would have been kicked out of the institution already. Too bad he is an economist, the only "science" field where you are not required to cite any data to support your theory.

Nov 05 02:38 AM

[Denis Gould:]

The Yen carry trade was based on Mrs Watanabe investing her savings in whatever yieldy product Nomura pushed out (the latest is US high yield bonds hedged into Brazilian Real - and no I'm not making it up). That had a realistic feel to it. The idea that people are borrowing dollars to invest in, say, equities thus giving themselves two separate ways of getting wiped out just doesn't seem as plausible. But because whenever stock markets wobble the dollar goes up the publicity hounds create an explanation, the more dramatic the better, and shovel it out to the speed talkers at Bloomberg TV and CNBC. It's the world we live in and it gives a ton of opportunities to people who have a framework to invest in.

Nov 05 04:19 AM

[JS Partners:]

If Nouriel Roubini was not as dramatic and theatrical - would he be as well known and famous as he is now? My guess is no.

It is the way he is and although I do not agree with a lot of the research he produces, he has been able to get the attention of a huge majority of the investing world however (in)famous that publicity is.

Nov 05 09:03 AM

[Aiki14:]

Roubini's accuracy in predicting the future is equivalent to Shooting an arrow at a target 100 yards away and hitting the planet Saturn

Nov 05 09:13 AM

[greaterdepr...:]

Mr. Prechter explored the "all the same markets" theme years ago.
He pointed out the tight correlation of virtually ALL assets (except the dollar) and that they were simply rising on a wave of liquidity (which was really just soon to be bad debt).

Nov 05 09:31 AM

[djackson:]

I have read some ancedotal evidence that the dollar carry game is being played out in China. The (surmountable) difficulty is getting the Renminbi.

Nov 05 09:53 AM

[Adam Makowka:]

Agree about your attack on Roubini's academic background. Yet I would question his lack of experience in trading more. What is your trading experience by the way? I feel you failed to address the key factor driving the markets today Dave, and it's fear of the pending anti free-market Obama bills, no? As soon as public health care is passed or defeated, energy cap and trade passed or defeated, and EFCA passed or defeated, the dolar will remain weak and stocks "hover". Please read a ghost piece on my blog submitted by Simon Jester about equities "hovering". Lastly, you should have addressed the price of gold more instead of tearing down some professor who never traded.

Nov 05 10:27 AM

[kennypowers09:]

well said. data continues to flow in that shows a reduction in overall credit, not to mention increases in the US savings rate. actual private investment net flows have been much higher into spread fixed than equity anyway.

roubini is a one trick pony. sadly, regular people will adore him even with his incoherant rants that most in academia and financial world ignore.

Nov 05 11:11 AM

[Wampeter, F...:]

I am a little suspicious of smear campaigns that start out with the "just an academic" attack.

For at least the last 15 years, CNBC and others have conditioned us to believe that only market players know what is happening and that "there really is an invisible hand".

Perhaps its time to really look at the data rather than let others interpret it for us?

Rather than look past the rhetoric that Roubini has to use to get any publicity in todays sensationilist driven business news you suggest he couldn't tell his *ss from a bubble which I think is unhelpful.

In general its a good article and IMO you correctly state that equities are currently overbought, but I dont think you adequately address the possibility of further problems in the US financial system such as continuing foreclosure problems until mid 2010; possible difficulties in the commercial real estate mortgages; or simply the public refusing to support continuing payments to our finco's.

A serious correction may occur but, IMO, it will be coordinated between government and large US Finco's.

For example, I think if you look at the deleveraging of Goldman Sachs and other financial players up until March of this year and their re-leveraging (on government backs) subsequently, you may find the debt driven equity upsurge you are looking for (but couldn't find).

As you correctly say, stocks are overbought - but we are now in the process of handing off the equity risk from the financial players who bought with government financing in March of this year to the more general public. The government - through pressure of an "imminent meltdown" from our Finco's - will facilitate this transfer with loose fiscal policy.

Pressure will be brought to bear on the government to maintain loose fiscal policy at least until this hand-off is complete IMHO. Once the public is all in and has off-loaded the risk from the finco's we are susceptible to a correction.

Nov 05 12:00 PM

[mna:]

If you preach doom long enough, eventually you'll get it right. It's like saying, "I predict that at some time in the future, things will suck." um.... duh?

Nov 05 04:02 PM

[ed233:]

Great article. Roubini seems to be an expert on all aspects of the market if you listen to what he has to say. Of course, most of what he has to say is a bunch of bunk. He recently got into a tussle with one of the world's leading commodity experts and found out that he really is talking to hear himself talk. When he can put his hard earned money on the line and make a substantial amount of money using his principles then I'll take to heart what he has to say. But until then he's nothing more than a mouth piece who has nothing positive to contribute. LOL Looking after your money.

Nov 05 07:11 PM

[Kimball Corson:]

As an economist myself, I can tell you Roubini is an excellent economist and definite is not a one trick pony. He has called many economic events correctly, as subscribers to his RGE Monitor know quite well. However, he is not a savvy investor and will be the first to tell you so himself. I too believe he has the mechanism wrong for translating the Fed's zero interest rate policy into global asset price inflation, but the fact is that inflation is ensueing from that policy and the presssure it places on other central banks. The IMF and the World Bank clearly recognize the problem and are noting that billions of dollars are now flowing into world wide financial markets as a result. In short, Roubini might be wrong here on some of the details, but he is well focused on a major developing problem in a way you and too many of those in Washington are not. This is not "muddle through" scenario, as you suggest.

Nov 06 12:02 AM

[Kimball Corson:]

To you naysayers, pay your money and subscribe to the RGE Monitor and you willl see (a) how generally mistaken you are, and (b) how much in the way of economic and research resources Roubini has available to him to help make the good predictions he does and not just the bigger ones you have heard about. Foreign governments and the wealthy are not just paying him megabucks for hot air, as too many here suggest. Those who hire him and RGE have been very pleased with his work. He is not the first to say that he works "very hard." But as is suggested here, he is not a trader/investor, he is an economist.

Nov 06 12:18 AM

[kennypowers09:]

I don't see why someone should have to pay for "evidense" of his theories. Most of the data is readily available from economists from the IMF, Fed, Intl agencies etc. It's well documented by several agencies, that net money flows have been much higher in fixed income products than it has been equity products. Why then does Roubini call for an equity bubble and not a fixed income bubble?

Jim Rogers has already called him out on this blunder and many others continue to see Roubini as a one trick pony. The probability of calling for a recession over a 10 year timeframe, is roughly the same as calling for expansion. His transformation into a deity by the media and small retail investors is extremely overblown and does them a disservice in using critical thinking skills of taking data and forming their own opinion.


On Nov 06 12:18 AM Kimball Corson wrote:

> To you naysayers, pay your money and subscribe to the RGE Monitor
> and you willl see (a) how generally mistaken you are, and (b) how
> much in the way of economic and research resources Roubini has available
> to him to help make the good predictions he does and not just the
> bigger ones you have heard about. Foreign governments and the wealthy
> are not just paying him megabucks for hot air, as too many here suggest.
> Those who hire him and RGE have been very pleased with his work.
> He is not the first to say that he works "very hard." But as is suggested
> here, he is not a trader/investor, he is an economist.

Nov 06 01:44 PM

[mbkelly75:]

I am an investor first, a trader second and not an economist (although I have some knowledge of it). Roubini may or may not be a one trick pony, but I have not seen anything from him that impresses me. I have the impression (not checked out from general lack of interest) that he might make a good contrarian indicator. If he is calling sell - buying might be a good idea and if he is saying buy - selling crosses my mind.

Nov 13 01:29 AM