The stock market is off to its worst start to a year since 1970, with the S&P 500 dropping 21% in the first half of 2022.
Meanwhile, many experts are warning that a recession is likely within the next two years, after the economy shrank an annualized 1.6% in the first quarter.
And renowned economist Nouriel Roubini, one of those who called the financial crisis of 2008, says we ain’t seen nothing yet.
“The next crisis will not be like its predecessors,” he wrote on Project Syndicate.
“In the 1970s, we had stagflation, but no massive debt crises, because debt levels were low. After 2008, we had a debt crisis, followed by low inflation or deflation, because the credit crunch had generated a negative demand shock.”
So what do we have in store for ourselves next?
Stagflationary Debt Crisis
“Today, we face supply shocks in a context of much higher debt levels, implying that we are heading for a combination of 1970s-style stagflation and 2008-style debt crises – that is, a stagflationary debt crisis,” Roubini said.
For fiscal 2021, ended Sept. 30, the budget deficit totaled 12% of GDP, the second worst ratio (after 2020) since 1945.
“When confronting stagflationary shocks, a central bank must tighten its policy stance, even as the economy heads toward a recession,” Roubini said.
And that’s what’s happening now, with the Federal Reserve having raised interest rates by 150 basis points since March and promising more to come.
It’s not just the Fed that’s implementing more restrictive policy, however. “Because today’s higher inflation is a global phenomenon, most central banks are tightening at the same time, thereby increasing the probability of a synchronized global recession,” Roubini said.
Bubbles Bursting
The central bank tightening is pricking financial bubbles everywhere, Roubini said, “including in public and private equity, real estate, housing, meme stocks, crypto, SPACs (special-purpose acquisition companies), bonds, and credit instruments.”
So what’s the outlook for US. stocks? “Most likely, they will plunge lower,” Roubini said. “In typical plain-vanilla recessions, U.S. and global equities tend to fall by about 35%,” he noted.
“But, because the next recession will be both stagflationary and accompanied by a financial crisis, the crash in equity markets could be closer to 50%.”
Even if the recession is mild, “history suggests that the equity market has much more room to fall before it bottoms out,” Roubini said.
“Though the current global situation confronts us with many questions, there is no real riddle to solve. Things will get much worse before they get better.”
