A Stock-Market Pessimist Speaks

 Market wag David Rosenberg explains why he remains bearish on the economy and bullish on Treasuries.

SINCE LEAVING MERRILL LYNCH two years ago, where he was the chief North American economist, David Rosenberg has lost none of his preeminence in auguring the direction of the U.S. economy. His prognostications of a double-dip in the economy haven’t been born out, at least for now. But so far he’s been more right than many sages in pointing out that the U.S economy isn’t living up to the most bullish expectations. In his daily briefings for Gluskin Sheff & Associates, a Toronto-based investment management firm, Rosenberg waltzes with characteristic aplomb through reams of data on topics ranging from just how bad the unemployment situation is (payrolls fell in September for the first time since December of last year and are still 7.8 million jobs short of the prerecession period) to how weak pricing power is these days (the latest consumer price index reading of zero change for a second month in a row only happens 7% of the time.)

Name: David Rosenberg
Age: 49
Title: Chief Economist & Strategist, Gluskin Sheff & Associates
Education: Master’s in Economics, University of Toronto
Hobbies: Chess, tennis, brick breaker

In a chat with Barrons.com this week, he burst the balloon of both the stock bulls salivating over more Fed stimulus, as well as those overly excited about a Republican mid-term triumph. Rosenberg’s only affection is for the still unloved Treasury bill.

Barrons.com: Last week’s data on retail sales in September, and the preliminary read on October New York state manufacturing activity, were both stronger than expected. What are we to make of that?

Rosenberg: The economy certainly is not double-dipping now, but it remains extremely fragile. The economy is in a 1% to 2% growth range, if you think about that, it means the economy is basically stagnant. That’s certainly no reason to rejoice. What’s normal in the second year of a post-recession recovery is that real GDP is accelerating, not decelerating, and is usually on track for a 5% annualized-rate of growth. Today’s numbers show things still operating on a pace that is not normal. The retail and Empire State numbers look very much like October 2007. Two months later, the recession hit. Consumer sentiment is running at levels consistent with recessions, not expansion. The ISM index, a more broad indicator of industrial activity, last month was on the soft side.

Q: Does it still seem likely to you that we’ll see a double-dip in the economy?

A: A double-dip is an outright contraction in economic activity. What we have on our hands is the next rung above that, which is an anemic pace of economic activity, certainly one that is not sufficient to absorb the excess slack in the labor market. There was legitimate concern three months ago that the economy could contract in Q3. It’s now unlikely there’ll be a contraction in Q3, but as for Q4, there’s still a long way to go. A lot of the supply side of the economy, which was a lot of the growth in Q3, came out of automotive production. And a lot of that reflected [the ramp-up to] the General Motors IPO. There was a 30% annualized-increase in production in Q3. That’s not going to be repeated in Q4. It could in fact stay flat in Q4, and it would just be a huge reduction in stimulus to growth. Auto sales are stuck in a range below replacement rates, 11 – 12 million [in annual North American-auto sales] is supposed to be a good number. But the normalized-run rate for the industry before the recession was 16 to 18 million autos. If there’s something that stuck out in the University of Michigan survey of consumer sentiment [on Friday, October 15th], it was that auto-buying intentions have been going down. Either the survey itself is a immaterial, or people are telling you they’re not going to buy cars.

Q: [Federal Reserve chairman] Ben Bernanke signaled last week what everyone expected, namely, that he’s inclined to provide further stimulus to the economy. What did you make of his remarks?

A: Bernanke believes the first round of quantitative easing (QE1) worked, and he thinks the second round, QE2, will work. But he sounded a bit more cautious this time around. People have been looking for shock and awe from the Fed, and they may now have to revise their forecasts. There’s no question the Fed will announce unconventional measures, most likely asset purchases, but he sounded a little on the cautious side in terms of how big it’s going to be.

Q: Well, there has been talk in recent weeks of something like $500 billion, perhaps, some even suggesting it might be $500 billion per quarter in asset purchases.

A: $500 billion was in surveys that were taken weeks ago, and you could even have heard people talking about $1 trillion. That’s ridiculous. For Bernanke, it’s all about managing expectations. He’s a believer in transparency, but he didn’t give the market what it wanted to hear.

Q: What happens November 3rd [the date of the Federal Reserve’s Open Market Committee Meeting] ?

A: The market has three bets now. The first is that there’s no more risk of a double-dip. I think it’s far too premature to dismiss that possibility. Second, there’s the bet that there will be a Republican sweep on November 2nd. There’s no question they’ll do well, but will they take the House, the Senate, or anything? And if they do take one or the other, or both, is gridlock really a good thing? In a time when we need political leadership, gridlock is not good. And third, there’s the bet that the Fed will come in with something big. I’m not convinced that they will. There are actually quite a few Fed bank presidents who are opposed to doing anything overly dramatic. On top of that, as to whether it works or not, in terms of compressing mortgage spreads and corp bond spreads, QE1 worked. But in terms of sustaining upward rates of economic growth, it didn’t. The markets have radically front-run the Fed here.

Q: I know that you are bullish on Treasuries right now. At an investment conference in New York this week, one hedge fund representative said that at some point, shorting Treasuries will be a good bet. Is that moment on the horizon?

A: The bond market has been the most detested asset class by the elite for the last five years. I have consistently had to defend Mr. Bond, who is both shaken and stirred. At Jim Grant’s investment conference earlier this year, he repeated his mantra that bonds are for losers. At that point the yield on the 10-year Treasury was at 4%. [10-year Treasury yield was at 2.58% most recently.] If you go back to the end of last year, to the Barron’s Roundtable, no one was recommending bonds. Bonds are still the enemy. Maybe that’s why the bull market continues unabated. The bull market won’t end until everyone embraces bonds as the asset class of choice at microscopic levels. I’ve heard so many times that shorting bonds is the best trade idea. Just go look at Byron Wien’s Top Ten Surprises list [published back in January. Wien is an advisor with Blackstone Group (BX)] Bonds are a sell right now, as we’re going into a little bit of a correction. But Byron had the ten-year note yield going well above 5.5% this year.

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