Roubini's call for a recession sounds more real now Analysis: Slow growth could get slower PrintE-mailDisable live quotesRSSDigg itDel.icio.usBy Nick Godt, MarketWatch Last Update: 4:43 PM ET Oct 27, 2006 NEW YORK (MarketWatch) -- Nouriel Roubini might be among the most bearish economists on Wall Street this year, but as shown again on Friday with the release of much weaker-than-expected third-quarter growth numbers, he's also been among the most accurate. That fact may be chilling, given that Roubini, a professor at the Sterns School of Economics at New York University and chairman of Roubini Global Economics, predicts a housing-led recession will be in place by the first quarter of 2007, or in the second quarter at the latest. Few on Wall Street dare make that prediction. Economists employed by investment banks, of course, may have an implicit interest in being cheerleaders for economic growth. Growth implies earnings growth and stock market gains, and therefore more money for their firms. Investors won't be drawn to the stock market if they know a recession is coming. Federal Reserve officials, likewise, continue to predict a soft-landing for the economy even as they again left interest rates unchanged on Wednesday. Yet, the facts remain that Roubini's forecasts are amongst the most accurate - and prescient -- so far. Third-quarter gross domestic production slowed dramatically to 1.6% in the third quarter from 2.6% in the second quarter and 5.6% in the first, the Commerce Department reported Friday. Roubini had forecast the GDP to come in at 1.5%, while the average forecast of economists polled by MarketWatch called for growth of 2%, as did most other surveys. And Roubini had been predicting this number since July, while at that time, economists on average expected third-quarter growth to come in at 3.1%. Similarly, for the second quarter, economists on average had expected the GDP to grow at 3.2%, while growth came in at 2.6%. Roubini had forecast growth of 2.5%. Now, looking forward, many Wall Street economists are forecasting a fourth-quarter rebound. "Expect today the usual spin with the soft-landing optimists - who were altogether wrong on second-quarter growth and even more wrong on third-quarter growth - having already started to spin the fairy tale of a fourth-quarter rebound," Roubini wrote on his blog Friday. The stock market, meanwhile, took the news of weak third-quarter growth in stride on Friday. The losses were cushioned by expectations of a rebound in the fourth quarter, according to Michael Metz, chief investment strategist at Oppenheimer & Co. The sharp drop in oil and energy prices seen in recent months are often cited by Wall Street bulls as cushioning the economic slowdown, as they lessen pressures on inflation and on consumers' wallets. "Unfortunately this interpretation confuses cause and effect," Roubini wrote. "Whenever the U.S. and the global economy have experienced a recession, oil and commodity prices sharply fell at the outset and during such a recession, as low global demand leads to lower commodities demand." Similarly, the stock market expects that the Fed's rate cuts will prevent the economy from dipping into negative territory. But the current problem, Roubini says, is a glut of homes and of automobiles which, as most gluts, tends to be interest-rate insensitive. Meanwhile, the bond market rallied on the GDP data Friday, keeping long-term bond yields firmly below short-term yields, a so-called inverted yield curve, traditionally a harbinger of economic recessions. Stocks on the Dow and the S&P have recently broken through all-time highs, seemingly all but completely dismissing predictions of a recession. One explanation offered by many Wall Street economists, and by Fed Chairman Ben Bernanke, for the divergence between what the stock market and what the bond market have been signaling is that massive demand for long-term bonds have kept their price high and their yields unusually low. But Roubini has a more simple explanation: While the bond market is correct, the stock market can remain delusional for a long while. Or as John Maynard Keynes, the father of Keynesian economics, once famously said: "The market can remain irrational longer than you can remain solvent." Back in March of 2001, the stock market and most Wall Street economists were still predicting that the economy would not experience a recession, while growth had already dipped in negative territory and would stay below zero for another quarter, Roubini notes. It was only in June, when evidence of a recession was at hand, that the market sold off. This time around, Roubini says the stock market can continue rising through Christmas based on expectations that the Fed will cut rates and stave off a recession. But he expects that the fourth-quarter GDP -- to be released in January -- will be an eye-opener, coming in at, or near, 0%, and will likely cause the market to sell off. By then, "expect a nasty bear market in equities - in the average recession the S&P falls by 28% - once the delusional dream of permabulls leads them to wake up to the reality of the nasty and deep recession ahead," Roubini wrote.