David Rosenberg's 2010 Outlook "The Recession Is Really A Depression"
With December almost done, and all the banks having already issued their rosy outlooks for 2010 (don't ask us how the trading desks are axed, but you be sure a certain sense of "contrarianism" permeates Goldman's traders), the objective third pary strategists begin chiming in. We present Rosie's 2010 outlook from Today's Breakfast with Dave piece, courtesy of Gluskin Sheff.
The credit collapse and the accompanying deflation and overcapacity are going to drive the economy and financial markets in 2010. We have said repeatedly that this recession is really a depression because the recessions of the post-WWII experience were merely small backward steps in an inventory cycle but in the context of expanding credit. Whereas now, we are in a prolonged period of credit contraction, especially as it relates to households and small businesses (as we highlighted in our small business sentiment write-up yesterday).
In addition, we have characterized the rally in the economy and global equity markets appropriately as a bear market rally from the March lows, influenced by the heavy hand of government intervention and stimulus. But in classic Bob Farrell form, 2010 may well be seen as the year in which we witness the inevitable drawn out decline that is typical of secular bear markets. There may be some risk in industrial commodities if global growth underperforms, but the soft commodities, such as agriculture, may outperform in the same way that consumer staple equities should outperform cyclicals in an environment where economic growth disappoints the consensus view. Gold is operating on its own particular set of global supply and demand curves and should be an outperformer as well, especially when the next down-leg in the U.S. dollar occurs. We are not alone in espousing this view — have a look at Why Consumes Are Likely to Keep on Saving on page C1 of today’s WSJ.
The defining characteristic of this asset deflation and credit contraction has been the implosion of the largest balance sheet in the world — the U.S. household sector. Even with the bear market rally in equities and the tenuous recovery in housing in 2009, the reality is that household net worth has contracted nearly 20% over the past year-and-a-half, or an epic $12 trillion of lost net worth, a degree of trauma we have never seen before.
As households begin to assess the shock and what it means for their retirement needs, the impact of this shocking loss of wealth on consumer spending patterns in the future is likely going to be very significant. Frugality is the new fashion and likely to stay that way for years as attitudes toward discretionary spending, homeownership and credit undergo a secular shift towards prudence and conservatism.
While hedge funds and short-coverings have been the major sources of buying power for the equity market this year, what has really impressed me is what the general public has been doing with their savings, which is to allocate more towards fixed-income strategies. Looking at the U.S. household balance sheet, what I see on the asset side is a 25% weighting towards equities, a 30% weighting towards real estate and there is obviously a lot in cash and deposits, life insurance reserves and consumer durables, but the weighting in fixed-income securities is less than 7%. So my contention is that this is the part of the asset mix that will expand the most in the next five to 10 years and I am constructive on income strategies.
What also makes this cycle entirely different from all the other ones experienced in the post-WWII era is that this is the first consumer recession we have witnessed where the median age of the baby boom population is 52 going on 53. The last time we had a consumer recession in the early 1990s, the boomer population was in their early 30s and they were still expanding their balance sheets. The last time we had a bubble burst in 2001 they were in their early 40s. Now they are in their early 50s, the first of the boomers are in their early 60s, and we are talking about a critical mass of 78 million people who have driven everything in the economy and capital markets over the last five decades. This cohort realize that they may never fully recoup their lost net worth, and yet they will probably live another 20 or 30 years.
So, what is happening, which is at the same time fascinating and disturbing, is that the only part of the population actually seeing any job growth in this recession are people over the age of 55. Everyone else can’t get a job or are losing jobs — there is a youth unemployment crisis in the United States of epic proportions and a record number of Americans have been out of work for longer than six months in part because the “aging but not aged” crowd is not retiring as early as they used to. My contention is that many retirees who took themselves out of the workforce because they believed that their net worth would provide for them sufficiently in their golden years are redoing their calculations and coming back to the workforce to make up for their lost wealth. They are seeking income in the labour market, not because they want to but because they have to in order to satisfy their retirement lifestyles.
So, instead of being tempted into capital appreciation equity strategies, for every dollar that the household sector has allocated to these funds since the March lows, over $10 dollars has flowed into income funds — bonds, hybrids, dividends and the like; the areas of the investment sphere that we have been recommending this year. We can understand that there are concerns over inflation, but the history of post-bubble credit collapses is that even with massive policy reflation, deflation pressures can dominate for years — this was certainly the case in the U.S.A. and Canada in the 1930s, and again in Japan from the 1990s until today. Income strategies in both cases worked well with minimal volatility.
Of course, all the talk right now is about reflation and all the efforts from the central banks to create inflation, but the facts on the ground show that the inflation rate for both consumers and producers has turned negative for the first time in six decades. Perhaps inflation is a consensus forecast but deflation is the present day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years. So, to protect the portfolio in this deflationary landscape, a pervasive focus on capital preservation and income orientation, whether that be in bonds, hybrids, or a focus on consistent dividend growth and dividend yield would seem to be in order.
Be that as it may, what has also become crystal clear is the attitude that the U.S. government has taken over the beleaguered U.S. dollar, which can only be described as benign neglect. After all, 2010 is a mid-term election year in the U.S. and the Administration will do everything it can to squeeze every last possible basis point out of GDP growth and to prevent the unemployment rate, the most emotionally-charged statistic of them all, from reaching new highs.
The decisions to give 57 million social security recipients another $250 and to not only extend the first-time homebuyer tax credit but to expand the subsidy to higher-income trade-up buyers smacks of populist economic policies that will stop at nothing to generate growth, even with the budget deficit-to-GDP ratio is already at a record of over 10%. While I still believe that a sustainable return to inflation is a long ways away, there is little doubt that we will see continuous efforts at policy reflation, which means that the U.S. money supply is going to continue to expand rapidly, which in turn is positive for commodities, which are after all priced in U.S. dollars.
On top of all that, it does appear from a volume demand perspective, that the secular growth dynamics in Asia, China and India in particular, have reasserted themselves and this part of the world is the marginal buyer of commodities. This is the key reason why the Canadian stock market, given its resource exposure, has continued to do very well in comparison to the United States, especially when the positive trend in the Canadian dollar enters the equation, and I expect this outperformance to continue.
Typical of a post-bubble credit collapse, I see the range of outcomes in the financial markets and the economy to be extremely wide. But one conclusion I think we can agree on in this light is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive such as in fixed-income and in equity sectors that lever off the commodity sector, under the proviso that the “experts” are correct on this particular forecast — that China and India remain the global growth leaders.
With that in mind, we were encouraged to see this on page B1 of today’s NYT — Cutting Back? Not in China: Rising Incomes Make it Easier to Splurge. As Dennis Gartman pointed out yesterday, there was a time (1820) when the U.S.A. was 2% of global GDP and Asia was 33%. That is tough for a lot of folks to swallow but maybe we will see in our lifetime a period when the Chinese economy does surpass the size of the U.S.A. (with 1.3 billion people, four times the U.S. population that actually seems quite likely).
After all, for the first time ever, China is going to be buying more vehicles than Americans will this year (then again, 20% of the Chinese aren’t exactly three-car families either) — 12.8 million units in China compared to 10.3 million in the U.S. And it’s not even fair to compare appliances any more either with consumption in China now up to 185 million (we are talking about washers, dryers, refrigerators, etc) versus an expected 137 million in the American market.
In Q3, Chinese consumers bought more computers (7.2 million) than the U.S.A. too (6.6 million). So while China is indeed still export-dependant and relies heavily on government infrastructure projects, there may be something to be said, at the margin, that consumer demand is also becoming an important contributor to its economic growth. Now keep in mind that most of this stuff is made in China and not in the U.S.A., so this is more of a commodity-input story than it is a U.S. export story.
China’s strategy of deploying its surpluses in assets around the world is quite a bit different than what Japan did with its surpluses in the 1980s. China is not into golf courses or movie studios as much as in gaining ownership of global resources in the ground. At last count, the country has signed trade deals with Africa to the tune of $60 billion (heck, that’s only 8% of the size of TARP, which is now going to be diverted towards a government-led job creation program in the U.S.A.). Have a look at the nifty article on the topic on page 11 of the FT —Africa Builds as Beijing Scrambles to Invest.