President of Rosenberg Research, David Rosenberg, poses for a portrait in Toronto, on Dec.,18, 2019.Christopher Katsarov/The Globe and Mail
This has been the charging bull of Wall Street that David Rosenberg didn’t see coming.
As the S&P 500 Index surged 45 per cent to all-time peaks over the past 18 months, Canada’s most prominent economist steadfastly steered investors away from making a broad bet on U.S. stocks. He suggested they look elsewhere for money-making opportunities – bonds, gold or other defensive areas of the market – often citing inflated valuations or an economy on the precipice of recession.
Some of his calls on specific investment opportunities worked out well. He identified Japanese equities as a top investment idea even before Warren Buffett allocated billions to the country, for instance.
But Mr. Rosenberg’s forecasting prowess got trampled on the one call that may have mattered most: the benchmark U.S. stock index that sets much of the direction for capital markets worldwide.
“In this business, everybody is myopically focused on the trophy, otherwise known as the S&P 500. And I have been dead wrong on that call. There’s no doubt about it,” Mr. Rosenberg said in an interview with The Globe and Mail.
His acknowledgement of being wrong was communicated in a note recently e-mailed to his clients, 70 per cent of whom reside in the United States.
But bearish views aren’t uncommon for Mr. Rosenberg, a contrarian economist who shot to fame while working for Merrill Lynch in New York as its chief North American economist in the early 2000s. There, he made several prescient calls about the U.S. housing and credit markets that eventually triggered the global financial crisis. He later returned to Canada to join wealth management firm Gluskin Sheff + Associates, before starting up his own firm, Rosenberg Research, in 2020.
His firm has since grown to a staff of 16 – including several economists and strategists – and its research offerings have expanded beyond his flagship Breakfast with Dave daily newsletter, which is frequently stuffed with more than 30 pages of charts and market commentary. He’s now offering reports that include a daily take on momentum opportunities for short-term traders, and a monthly report called Strategizer that assesses a broad array of indicators that include sentiment, technicals, valuations and earnings fundamentals.
These quant-based models that Rosenberg Research produces can often be at odds with the frequently bearish, sharp-tongued commentary written by Mr. Rosenberg himself in his main newsletter and his newspaper columns. The momentum model has been consistently bullish since Nov. 8 of last year while the Strategizer – which delves into asset allocation for investors with a one-year time horizon – turned bullish in late 2022, around the time U.S. stocks started making a sustained upturn, the economist notes.
More recently, the Strategizer started flashing red on U.S. equities. Taken together, Mr. Rosenberg says the momentum and Strategizer models “are suggesting this is stock market rally that you can rent but you don’t necessarily want to own. It’s telling you as an investor that if you don’t want to part with your beloved equity portfolio, it might be time to start at least selling some call options against it ... In other words, buy some downside protection.”
He himself remains convinced markets are heading for a fall and that the U.S. and Canadian economies will both be in a recession before this year is out.
“You will rarely find me in the consensus thought process. I focus on valuations and right now the U.S. stock market is in the top 10 per cent of valuations of all time,” Mr. Rosenberg says.
Which of his models to follow, or whether his own views should trump all, depends on your time horizon, he says. And as a long-term investor, he’s putting his own money behind his own experience and intuition, even though taking such bearish positioning hasn’t always worked out in the past.
Over a two-hour interview, Mr. Rosenberg told The Globe more about his latest views on markets and the economy. Part two of this interview, in which he discusses his views on housing and other challenges facing Canada, will come later this week.
Could you expand upon how you are personally invested?
I have dialled back my equity exposure to where it was back in 2007 [prior to the financial crisis]. That is how bearish I am. ... The S&P 500 is the most, by a country mile, expensive stock market on the planet. It’s a market that’s rallied 30 per cent in price in the past year, but earnings are up just 4 per cent. ... It’s been purely multiple-driven – the forward price-earnings multiple has gone from 18 to 21 in a 12-month span.
You can buy a three-month T-bill at 5.4 per cent. Or you could buy the S&P 500 at a 4.8 per cent earnings yield. Historically, when investors had a more rational mindset and perhaps a little less exuberance, they wanted to get paid to take on equity risk. But now they’re paying to take on equity risk. And I’m just not willing to advocate that anybody should do that even as this market flies in my face.
Lately we’re seeing market breadth widening out – for instance, small caps have been getting a significant bid. Has this given you some reason to become a little more constructive on the U.S. stock market?
Not really. And it’s because this is a case of where your assumptions drive your conclusions. So, the assumption is that we are in either an elongated soft landing or we’re in a no landing. And hence, the recent move into the more cyclical parts of the market.
I am still in the recession camp. I know that everybody’s throwing in the towel on the recession. But I don’t think the business cycle has been repealed. Interest rates matter and interest rates work their way through the economy with lags that can sometimes last a few years. ... You know, the Federal Reserve started tightening policy in June of 2004. They were finished two years later. And then the bad stuff didn’t hit the fan till the end of 2007. The recession that nobody saw coming. ...
Nine of the 11 sectors of the S&P 500 are trading at multiples that exceed their long-term averages. And only two are trading inexpensively, and those are energy and the REITs, followed by utilities, which are just moderately overvalued. Everything else is trading at egregious multiples based on the historical norm.
You could justify these multiples when interest rates were on the floor, but interest rates are back to where they were in the summer of 2007. When you normalize the multiple for the interest rate environment we’re in, the fair value multiple is 16, not 21. That is the extent of the overvaluation and the extent investors are paying for the future earnings stream.
The consensus is very bullish, with 11 per cent earnings growth in the forecast for this year. The market is priced for something that is almost four times that.
I think you’ve also said redeploy money into the bond market, right? That was perhaps your strongest call over the past couple of years.
Well, that call didn’t work so well. I still believe that inflation was transitory, but beauty is in the eye of the beholder. It was an inflation bulge that lasted 18 months. The question is: In the overall annals of economic history, is 18 months transitory or something more permanent? ... I did not see 8 per cent inflation in Canada or 9 per cent inflation in the U.S. But we did. And then we had this massive overreaction by the central banks, outside of the Bank of Japan.
When you look at correlations for what matters most for long-term government bond yields, it’s the cost of carry – it’s the expectation of what central banks are going to do. And frankly did I ever think we’d go from zero to 5.5 per cent on overnight rates? I thought that was actually a pretty low odds event, but it happened. So, that really dragged the entire yield curve higher. So, for a couple of years, that bond call was a really bad call [bond prices move inversely to yields]. But, you know, since last October it’s been working out pretty well. You actually made money in bonds through the daily wiggles.
In your opinion, why has the U.S. economy surprised to the upside so much and how long can the soft landing mode last?
The prevailing belief is that the U.S. economy is doing phenomenally well. I think that is a misconception that’s generated by the fact that the two most popular numbers are gross domestic product and non-farm payrolls. And we have dichotomies between the various pieces of economic data and within these reports. I haven’t seen anything like this in my 40 years in the business.
So, yes, if you’re looking at real GDP, it’s up to over 3 per cent in the past year, and you’d be thinking that is like a mini-boom. However, real gross domestic income, which comes out with a lag, is flat year over year. Industrial production is flat year over year.
What’s going on here? The reality is income and production are not levered, but spending is levered. And GDP is all about spending.
Now what explains that divergence?
We had the last leg of the excess savings file in the personal sector become fully unwound in the past year, and that came as a big surprise to me. I did not think that we would finish the year with the savings rate flirting around 3.5 per cent, which is less than half of the pre-COVID-19 norm. You see, historically, when confronted with a stimulus cheque, the household sector saves half and spends half. All of it got spent. YOLO became the acronym – you only live once. Revenge spending. So we had a real behavioural shift.
Layered on top of that, we had a consumer credit boom of historical proportions, even with 20 per cent plus interest rates, we saw double-digit growth in credit cards. So, that was another thing that showed up in GDP.
And then the third thing was the fiscal expansion – all the subsidies in the CHIPS Act and the oxymoronic Inflation Reduction Act. ... Fiscal policy alone, both directly and indirectly via the multiplier impacts, accounted for two-thirds of the 3 per cent real growth last year. And then 1 per cent was divided among a credit card boom and the last leg of the rundown of excess personal savings.
So, actually, when you strip out those items, GDP growth was flat and consistent with flat income growth and flat production growth. If I was an equity analyst looking at this thing, I would have an asterisk at the bottom of the report saying these are non-recurring items. There is no more fiscal stimulus this year; maybe there will be after the U.S. election. The U.S. right now is running fiscal policy on a set of continuing resolutions. There is no more fiscal stimulus this year. And the excess savings file has been officially run out.
And now we have this other situation where it is a case of buyer’s remorse, because the delinquency rates in credit cards, which are now a US$1.3-trillion liability, the same size as subprime back in 2007, have gone up to their highest levels since 2012.
So, when you look at the survey data, you’re going to see the banks have dramatically increased the rejection rates on new credit cards and higher levels of debt. We’ve taken out a lot of these temporary crutches that acted as a very strong antidote to what the Fed has done with interest rates.
The lags from what the Fed has done have not fully run their course, but these temporary influences that gave us this allure of prosperity in the GDP accounts, they are in the rear-view mirror.
It sounds like you are confident that there will be a U.S. recession before the presidential election in November.
That’s my base-case scenario. Look at the employment side. Everybody bows down to the altar of non-farm payrolls. However, has anybody noticed that every single month we’re seeing downward revisions to the previous month, which again, provides this false glow to the most recent piece of data. ... Part of it is the fact that in this post-COVID environment, the response rates to a lot of this data has been very low. That’s why we’re seeing these revisions.
At the same time, companies are cutting the workweek, so we’re adding more bodies but cutting their hours. There are cracks emerging in the labour market that aren’t fully appreciated.
The Toronto Stock Exchange recently hit an all-time high. You’ve been more constructive on Canadian stocks than U.S. equities for a while now, mostly based on valuations. It’s finally getting a tailwind, but at the same time, the Canadian economy isn’t faring nearly as well as the American economy. Do you still think the TSX is set for outperformance from here?
Well, don’t forget that the TSX has a very low correlation with the Canadian economy. It’s resource based, with a lot of banks, but those banks are globally diversified, with a much higher correlation to global GDP than to Canadian GDP. What holds the Canadian market back is the composition, because we just don’t have the same orientation toward flashy growth stocks. We don’t have a Nvidia, and we don’t have an Apple, and we don’t have an Amazon. We are more value.
I think that the relative tailwind in Canada may come from the fact that the inflation numbers here are behaving better of late. I think the Bank of Canada has more of a green light to start cutting interest rates than the Fed does. That should be good news for bonds and should be good news for stocks relative to the U.S.
On top of that, at least Canada provides an investor with a positive equity risk premium. You get paid for the risk of taking on equities in Canada on a relative basis [to risk-free bonds] more than you do south of the border. So, if you have to be in the equity market, Canada’s a better proposition.
What specific area of the bond market do you recommend right now?
Notwithstanding the monthly gyrations, I think we’re into an era now of disinflation, not inflation. And I think that, as far as central banks are concerned, the rate cycle has peaked, which means the next moves will be down. What’s going to happen is that short-term rates and front-end yields will come down harder, but because of the convexity, the total return potential is going to be far more powerful at the longer end of the yield curve.
So, I like 30-year bonds. I want maximum duration right now, knowing that the recession risk has not gone away. There’s no doubt that the biggest decline in interest rates will be at the front end of the yield curve, but there’s minimal duration there, so you’re not going to get the bang for the buck. I’m not saying that you’re buying bonds right now for the yield; you’re buying for the capital gains. I actually think that there’s a very good chance that the 30-year U.S. Treasury will deliver a 20 per cent total return over the next 12 months.
Despite the big rally in Japanese stocks, is it still your highest conviction investment idea?
100 per cent. It has been for the past two years and remains our highest conviction call. ... It’s a US$6.5-trillion market, and it has a fundamental tailwind and it’s under-owned by local investors and undergoing a fundamental re-rating.
People ask, Why do you want to invest in a country where the population is going down? In Japan, real per capita income and output are going up. It’s about how you mobilize your population as the population goes down – the female participation rate is going up exponentially and it actually set a record high.
(Answers have been edited for brevity and clarity)