Recovery can’t last: Rosenberg

Hold onto your hats and grab your anti-nausea meds. If David Rosenberg is right, the latest correction isn’t over, not by a long shot.

Rosenberg — called “the man with crystal balls” by Gluskin Sheff & Associates, the firm that appointed him chief economist and strategist earlier this year — says the current market rebound is unsustainable and liquidity will only take things so far.

During his keynote speech to Canada’s Venture Capital & Private Equity Association in Toronto on Tuesday night, Rosenberg poked holes in the notion that the market has any hope of sustaining a v-shaped recovery path. He also says current inflation concerns are unwarranted.

“Inflation? Are you kidding me? Why, because the government is trying to stabilize things? Two years after the biggest credit collapse of our lives and people have inflation on the brain,” he said. “It’s not even on the intermediate horizon as far as I’m concerned. Not until we get into a new credit cycle. All Bernanke is doing right now is patching a leaky boat.”

Rosenberg discussed the political implications of current trends, hashing out a prediction about the challenges facing U.S. president Barack Obama. He also discussed the asset classes he expects will be growing fastest in the years to come.

Corporate bonds are his number one pick, and he expects fixed income to be the fastest growing asset class on the average household balance sheet. The market is currently pricing bonds for 2% GDP growth, which is not entirely realistic in his view, but it is withing a range he can live with. In early 2009, he says this asset class was low-hanging fruit for investors — “Armageddon” pricing had bonds priced for -10% GDP growth.

As for stocks, he says too much risk remains and growth expectations are too optimistic. Using the S&P500 as his measure, Rosenberg says stocks are currently priced at levels more appropriate for 4% GDP growth.

“I’m not going to say this is impossible but a 1 in 10 chance (of this happening) is my base case scenario.” Then again, he adds, “maybe the stock market has got it right. In that case, the 4% growth is already priced in.

“If the S&P 500 were priced for corporate bonds at 2% (GDP) growth, we’d be back at 850 points.” The S&P 500 is weighing in just over 1,000 points. “Frankly, 850 is what I’m looking for. I just don’t know when that’s going to happen.”

Operating earnings and valuations are also causes for concern. Price-to-earnings multiples and forward operating multiples are currently higher than they were at the market peak in October 2007. Based on operating earnings, the market is not ridiculously priced, he says, but it certainly is expensive.

Moreover, the latest run-up in stock prices isn’t sustainable, even if the recession is technically over — another detail the “contrarian’s contrarian” disputes. Bear markets have three stages, he explained. The first stage, a sharp drop, occurred in March. The second, a reflexive rebound, is happening now. The third stage, a drawn-out fundamental downtrend, still lies ahead.

“Even if the recession is technically over, what sort of recovery lies ahead is anybody’s guess.”

Quoting directly from one of his latest Breakfast with Dave reports, Rosenberg says the economy is heavily medicated with government stimulus and that there’s no way of knowing what it looks like beneath the surface. “A 60% rally in a short period of time is not the hallmark of a bull market, my friends. That’s the hallmark of a bear market rally.”

Those holding out for a V-shaped recovery will likely be disappointed by Rosenberg’s predictions. Such recoveries, he says have happened historically, but only during a secular (long term) credit expansion. This trend started in the 1980s once consumers got their feet on the ground and learned to live with credit, following the introduction of Diner’s Club cards back in the 1960s.

“Right now we are living through a post-bubble credit contraction,” he told the group. “This is not some plain vanilla, garden variety manufacturing inventory recession where you get inflation, interest rates go up, the Fed cuts rates…and then it’s off to the races. This is a private sector credit contraction of epic proportions and it’s continuing.”

Looking forward, he urged the money managers gathered to keep an eye on the dollar. He also predicted a few unemployment-related political rough spots that U.S. leaders will need to grapple with over the next two years. All those pushed into part-time employment will recover their full-time status, if the economy does pick up, and employers will move back to standard length work weeks. This is good, but the trend won’t move unemployment numbers, which will, in turn, become a political albatross.

November and December 1982 saw the highest unemployment rate (10.8%) recorded since the Second World War. The U6 unemployment rate, which includes measures for underemployment and part-time employment, will come down as companies reinstate full-time hours and call back employees, but the standard unemployment rate itself will continue to climb. The official unemployment rate could settle somewhere in the “unhappy middle” of those two rates, around 12%. As well, all the boomers who are “returning to work for (wages) less than those they left for,” are pushing youth unemployment up to 25%.

“This is an unmitigated disaster,” he says. “I don’t know how you trade around it. I don’t know what it means for future productivity growth.”

Mid-term elections are scheduled for November 2010 in the U.S. If unemployment rates break the 10.8% mark set back in 1982, “it is no longer George Bush’s recession. It is now Barack Obama’s recession and that is going to make headlines everywhere.”

“Nobody looks at the U6; the U6 will be coming down. But the headline unemployment rate will make all the papers.”

Although U.S. dollar deflation is not a prediction, he calls it a risk. “You can’t take rates negative. How much stimulus can you do fiscally? Keep an eye on the dollar, it’s the next policy lever.”

Kate McCaffery is a Toronto-based freelance financial journalist.

(09/23/09)