Rosenberg On The 8 Areas Of Behavioral Change In 2012

It seems the market's psychology has shifted, in its wonderfully temperamental and instantaneous manner, once again as the last great hope of Thomas Lee and his cohorts is removed. What better time than for David Rosenberg, of Gluskin Sheff, in his inimitable way, to introduce his outlook for 2012 in the form of eight behavioral changes that he expects to overwhelm market psychology in the coming months. Political, financial, and economic transitions for the US, Europe, and China respectively will dominate the coming year and as Rosie points out, the ability to recognize change at the margin (such as basis traders in European sovereigns) is going to be critical in 2012. The shift from one of cyclical extrapolation to secular change is always a hard one to navigate and tactical asset allocation will become foremost in most people's minds over longer-term strategic considerations. The global economy will be forced to endure the mother of all deleveraging cycles as we move through 2012 and capital preservation and income must dominate investment strategy as Rosie's 8 themes play out.


The reality of this new paradigm of secular credit contraction may be coming into sharper focus by the general public than it is for the typical economist, strategist or market pundit. And as we have seen in the spreading sovereign debt and banking crisis in Europe, these challenges are global in nature. As such, one can reasonably expect to see standards of living in the developed world in particular pressured by daunting demographic trends and the growing realization that underfunded pension funds will have to be resolved somehow.

The American consumer and the government behaved irresponsibly during the credit bubble era of 2002-07, behavior that we are still paying the price for today. As we found out in 2011, the behavior among European banks, governments and households during the prior bubble era was equally galling, but their current problem of sovereign credit defaults and weak banking structures within a monetary union (that is actually a larger economic region than the United States) has taken the global debt crisis to a new and potentially more dangerous level than we experienced in the aftermath of the 2008 Lehman collapse.



As for governments, they hit the debt wall at various stages in the past year and the list of countries either being downgraded or shut out of global capital markets is growing by the week, if not the day. Suffice to say that the combined OECD government debt-to-GDP ratio, in a span covering just four short years, has soared an unprecedented 30 percentage points to stand in excess of 100% for the first time in the post-WWII era.


One thing seems reasonably certain: the global economy is going to endure a significant deleveraging cycle as we move through 2012 - one that will affect most if not all parts of the developed world. It will be accomplished by some combination of default and write-downs, debt repayment and rising savings rates. All this promises to be very deflationary and we will have to invest with that prospect in mind, and all the behavioral, political and social shifts that are bound to ensue.


1.    Frugality on the part of the global consumer (living within our means; retirement with dignity)

For those who were betting on elevated portfolio returns to deliver adequate retirement savings, time has run out. They will have to save the old fashioned way at some point.


Up until now, it has been difficult to demonstrate a clear, broad-based trend toward frugality on the part of consumers. To some degree the haves are offsetting the behavior of the have-nots, but now that the equity wealth effect is over, the upper-echelon spenders are headed for the down escalator. The most recent resurrection of consumer spending this fall after a first-half lull clearly appears to have borrowed from the future when seen in the light of negative changes in household income and the plunging personal savings rate.

2.    Austerity on the part of sovereigns (spending cuts/tax reform)

It is difficult to unequivocally assert that the fiscal challenges in Europe are any worse than those in the United States. But each country and region does have their own unique circumstances and challenges.


What seems to be common is a relatively high degree of chaos.

3.    Nationalism (an umbrella for protectionism and isolationism: mean reversion for globalization)

Isolationism falls under the umbrella of nationalism, and so does protectionism. An increase in nationalism will mean that we will need to be extremely thoughtful in our selection of dividend paying stocks.    Political movement along the ideological and fiscal spectrum (from gridlock to change)

Increased nationalism will impact trade, defense budgets, business costs, currencies, commodity prices and all the productivity factors that have made globalization such an economic positive, particularly in the post-Cold War era. 

4.    Political movement along the ideological and fiscal spectrum (from gridlock to change)

The outcome of the presidential race may well be the most consequential development of 2012, if not the most important election since Reagan defeated Carter in 1980.

But what we are most interested in determining is how rapidly politics, particularly in the developed world, can escape gridlock. Historically, secular economic peaks are accompanied by political extremes, and this time was no different. If politics can make its way from polarization toward the center, the outlook for economic stability improves dramatically, in almost every case.

The U.S., like much of the developed world, will be forced to find ever-creative ways to pay down accumulated debt. Inevitably "taxing the rich" and/or wealth confiscation cannot be ruled out, especially if social stability is threatened by lingering high rates of unemployment, particularly on the youth, adult males and the uneducated.

5.    Geopolitical change (wars, elections and regime changes)

Already in Europe, seven governments have been toppled by the debt crisis; Greece and Italy are now run by caretaker technocratic leaders and a political crisis is brewing in Belgium


We also have French presidential elections this spring and Germans head to the polls a year later. The Arab Spring has unleashed rounds of instability, as evidenced by recent events in Egypt, Turkey, which has drifted away from the West in several crucial respects in the past year. Vladimir Putin's renewed ascendancy in Russia can hardly be construed as a settling development. We will be looking for geopolitical improvement in 2012, even if that is not saying much.

6.    Changes in inflationary/deflationary expectations

If a recession is in store for 2012, then the bear market in equities, real estate and most cyclically sensitive parts of the investing landscape has certainly resumed.

The dilemma for policymakers this time around is that they are out of bazookas. Perhaps 2012 will be the year when investors stop fearing inflation and instead embrace the more obvious fundamental conditions that are leading to deflation: declining credit in the face of ongoing expansion in the supply of goods and services.

7.    Changes in growth expectations

Consensus estimates for GDP growth have been on a roller coaster for the last few years. The fear of a "double-dip" has alternated with the hope for "escape velocity" frequently since the recovery officially began in mid-2009.



We will be watching for evidence that consensus expectations gravitate toward acceptance that we are deeply entrenched in recession before we expect to see the next low in the equity markets and, conversely, the next (and possibly last) low watermark in bond yields. Because profit margins are either at cycle highs or all-time highs, even a mild economic contraction could end up exerting a powerful dampening impact on earnings growth.

8. Changes in asset allocation preference (fund-flows/de-risking)

Many investors increasingly want preservation of cash flow as well as preservation of capital. We concur and have consistently recommended a focus on S.I.R.P. — safety and income at a reasonable price, with a primary focus on stability and prudent risk-taking.


1.    Focus on safe yield: High-quality corporates (non- cyclical, high cash reserves, minimal refinancing needs). Corporate balance sheets are in very good shape.
2.    Equities: focus on reliable dividend growth/yield; preferred shares ("income" orientation).
3.    Whether it be credit or equities, focus on companies with low debt/equity ratios and high liquid asset ratios - balance sheet quality is even more important than usual. Avoid highly leveraged companies.
4.    Even hard assets that provide an income stream work well in a deflationary environment (ie, oil and gas royalties, REITs, etc...).
5.    Focus on sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry/some sort of oligopolistic features, a relatively high level of demand inelasticity (utilities, staples, health care — these sectors are also unloved and under owned by institutional portfolio managers).
6.    Alternative assets: allocate significant portion of asset mix to strategies that are not reliant on rising equity markets and where volatility can be used to advantage.
7.    Precious metals: A hedge against the reflationary policies aimed at defusing deflationary risks— money printing, rolling currency depreciations, heightened trade frictions, and government procurement policies.

For 2012, tactical strategies will also be crucial, at least as much as in the roller- coaster ride of 2011 (when strategists talked of 20% price appreciation in the classic third year of the presidential cycle).



Investors should be making a special effort to fight dogma and keep an open mind in the coming year — looking to take advantage of both long and short opportunities, focusing on dividend growth and yield in the equity market, and sticking to fixed-income — though we must be acutely aware of when this strategy becomes a "crowded trade" and a widespread consensus viewpoint.

Deflation has re-emerged as the dominant trend — not inflation — as the deleveraging cycle that is ongoing in the United States has now engulfed much of Europe.


  Frugality has also reared its head again as it pertains to the broad retail sector, another deflationary force, at a time when the U.S. unemployment rate remains stubbornly stuck above 9%. As such, it is absolutely imperative to remain focused on high-quality investments with preservation of capital attributes, and to use the inherent market volatility that is part and parcel of every post-bubble deleveraging cycle to one's advantage by becoming ever more tactical and opportunistic in long-short "relative value" strategies.