Market Watch: Why the Stock Market's New Exuberance May Be Irrational

Article by Nouriel Roubini in The Wall Street Journal Market Watch

This past May and August, escalations in the trade and technology conflict between the United States and China rattled stock markets and pushed bond yields to historic lows. But that was then: since then, financial markets have once again become giddy.

U.S. and other equities are trending toward new highs, and there is even talk of a potential “melt-up” in equity values.

Not all is well

Yet there is much to suggest that not all is well with the global economy.

For starters, recent data from China, Germany, and Japan suggest that the slowdown is still ongoing, even if its pace has become less severe.

Second, while the U.S. and China may agree to a truce, the ongoing decoupling of the world’s two largest economies will almost certainly accelerate again after the U.S. election next November. In the medium to long term, the best one can hope for is that the looming cold war will not turn hot.

Third, while China has shown restraint in confronting the popular uprising in Hong Kong, the situation in the city is worsening, making a forceful crackdown likely in 2020. Among other things, a militarized Chinese response could derail any trade deal with the U.S. and shock financial markets, as well as push Taiwan in the direction of forces supporting independence — a red line for Beijing.

Central banks are reaching the limits of what they can do to backstop the economy, and fiscal policy remains constrained by politics and high debts. To be sure, policy makers could turn to even more unconventional policies — namely, monetized fiscal deficits — whenever another downturn occurs, but they will not do so until the next crisis is already severe.

While recent mass protests in Bolivia, Chile, Ecuador, Egypt, France, Spain, Hong Kong, Indonesia, Iraq, Iran, and Lebanon reflect a variety of causes, all are experiencing economic malaise and rising political resentment over inequality and other issues.

Whenever the next severe downturn occurs, high and rising private and public debts will prove unsustainable, triggering a wave of disorderly defaults and bankruptcies.

The disconnect between financial markets and the real economy is becoming more pronounced. Investors are happily focusing on the attenuation of some short-term tail risks, and on central banks’ return to monetary-policy easing.

But the fundamental risks to the global economy remain. In fact, from a medium-term perspective, they are actually getting worse.

To read this article in Market Watch in its entirety, click here.