Rosenberg's View For 2010 "A Return Of Volatility"
For those strapped for time, here is a comprehensive 4 minute Bloomberg TV interview with David Rosenberg which recaps some of the recent trends the Gluskin Sheff Strategist has been discussing, including the sovereign debt crisis, corporate earnings, and small business performance.
For those wishing to dig deeper into the observations, below is the key take home from today's Breakfast with Dave (full piece here).
In several of my recent musings, I put forward the idea that economic, political and market trends are likely to continue the pattern of alternating direction from one year to the next. In other words, what worked in 2010 is not likely going to work in 2009 any more than what worked in 2008 did not work in 2009; in a nutshell, we are still on this post-bubble roller-coaster ride. If you go back to the initial bounce off the depressed bottom in the early 1930s, what we had for a decade off the bungee-jump was intense volatility. The same holds true for Japan in the early 1990s, and ever since. Considering the volatile, alternating character of the financial markets over the last three years there should be no need to back away from an overall cautious investment strategy that involves capital preservation and income generation, notwithstanding the sharp but inevitably fleeting market rallies that are typical in a post-bubble credit collapse.
From my lens, it now looks like the global economy is going to weaken after a few quarters of bounce-back that was caused principally by massive government intervention and stimulus. For illustrative purposes, we ran some simulations and found that absent the massive amount of monetary, fiscal and bailout stimulus last year, real GDP in the U.S. would have likely contracted as much as 4% in 2009 instead of the posted 2.4% decline; the third quarter would have contracted 1% (not gained 2.2%) and Q4 would have been down 1.5% (not the ripping 5.7% jump that is destined to be revised in any event).
The stimulus we experienced in 2009 is unlikely to be repeated in 2010 for a number of practical and political reasons. Scott Brown’s recent victory in the U.S. Senate race was a message for the government to go easy on the public purse, among other things like socialized health care. In addition, economic growth will be increasingly burdened by all of the government debt that has been created to cushion the private sector collapse.
Moreover, all of a sudden the viability of the Euro is now being called into question because of the massive deficits and debts that have been accumulated by countries like Greece, Spain, Portugal, and even France and Italy, and while sovereign credit risks are not really a Canadian problem, when you are a small open economy in a highly integrated global capital market then it is hard not to get caught up in the crosscurrents as we saw during the Asian crisis just over a decade ago and the global financial meltdown this time last year.
Within the next three years, expect to see more than half the U.S. fiscal deficit to be accounted for by interest costs on the growing stock of government debt. This implies that the fiscal problem will become increasingly structural over time and the need to bring deficits and debts in the public sector into more manageable levels relative to GDP will entail significant cuts to program spending, higher taxation (or both), which in turn is going to have significant implications for U.S. domestic demand and the flip side of that, Canadian export growth. (This may be one reason why the Bank of Canada is willing to nurture a red-hot housing market as a partial antidote, especially as Finance Minister Flaherty begins to tighten up on CMHC guidelines).
It may be prudent to view the January selloff in risk assets in general and equities in particular as a microcosm of what to expect for the rest of the year. However, at the same time, I would contend that the most dangerous mistake anyone could make right now would be to extrapolate the bounce off last year’s market bottom into the future. Many of the tailwinds that powered the stock market to a 70% gain from the March low have morphed into headwinds that have already caused the bear market rally to stall.
When the economy and financial markets were in free fall, global central banks and governments took drastic steps to fix the problem, using record-low interest rates and trillions in stimulus money. The goal of stabilizing the financial situation worked wonders bringing markets back from the brink of collapse. But nearly 12 months after the March 2009 stock market bottom, those same remedies are in the early stages of being taken back. Credit-tightening moves are not just happening in China but in India as well. The Federal Reserve, which now holds about $1 trillion in residential mortgages on its balance sheet and has offered unbelievable support for the housing market, is embarking on an exit strategy; and there is a high expectation that the Canadian federal budget on March 4 is going to unwind some of the dramatic fiscal stimulus that Mr. Flaherty has unleashed over the past 18 months.
As a result, investors are growing more risk averse as they question the macroeconomic outlook as the government withdraws its support. Moreover, as last year’s sugar high continues to wear off, what we can expect to see is a return to what can only be described as heightened volatility in the markets, and the need to shift towards less cyclical and more defensive and income-oriented strategies that work well in a period of increased economic uncertainty.
After the reflexive rebound in global equity markets, and considering the lofty valuations in many risk assets, we need to be extremely thoughtful about our asset allocation decisions in the context of the likelihood that the primary trend is still one of deflation, both in consumer prices and asset values, especially in residential and commercial real estate. What is ongoing is the trend toward household balance sheet rebuilding and bad loan resolution, and now coupled with sovereign default risks, especially in Europe.
Overall, if the primary trend for the economy, credit and equity prices is down and 2009 was indeed a countertrend bounce, then the appropriate exercise is to consider ways to capitalize on the spectacular rally in risk assets off the lows last March and determine how we can all still make money in 2010 on a risk adjusted basis.
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