The Rotman School of Management hosted David Rosenberg for its Investing Experts Speaker Series on January 29. Rosenberg is the Chief Economist and Strategist at wealth management firm Gluskin Sheff, and he was previously the Chief North American Economist at Merrill Lynch Canada. He reflected on current market forces through his experiences in investing from within the private sector.
The talk was titled “The Year of the Pig (Lipstick Won’t Help!),” referencing the Chinese zodiac and riffing on the famous porcine expression of putting lipstick on a pig. Rosenberg said that branding changes being undertaken by the US Federal Reserve System (Fed) are a futile attempt to disguise an impending economic downturn.
If you’re on time, you’re late
With a commanding tone and sardonic remarks such as “economists are accountants with personality,” Rosenberg delved into the topic at hand by introducing a key principle of investing: “Be cognizant of what’s priced in.”
Referencing Donald Coxe, one of his mentors, Rosenberg relayed the prescription to “beware of the front cover affect.”
Much like how the freshness of viral memes are played out by the time they appear on the Ellen DeGeneres Show, he said that stories that appear on the front pages of financial magazines aren’t novel and that their problems have already been factored into the price of equities. With the investor’s goal of buying low and selling high, this provides little margin for profit.
“You want to buy the page B16 story on its way to page A1. Now when it gets on page A1, the story is over,” he said.
Despite the length of the current decade-long US economic expansion, it was his self-described contrarian thinking and a front page story in The Economist, titled “The bull market in everything,” that led Rosenberg to heed his own advice and prepare for the economic downturn of a bear market and possible recession.
Rosenberg emphasized the significance of interest rates in understanding market behaviour. “Interest rates! That is what is important, because when you’re talking about stocks, or bonds, or real estate, anything that generates an earnings stream, you have to know where interest rates are going or you’re going to be completely lost.”
After the 2008 market crash and resulting recession, lower interest rates set by the Feds were used to induce spending as a means for recovering and reinvigorating the stagnant market. This was followed by quantitative easing (QE) — a large scale purchase of government debt and private assets by the central bank. While an unusual policy move, QE became a popular mechanism for central governments to introduce cash into the market when they were unable to lower interest rates much further.
According to Rosenberg, these policies have led to a ballooning of the stock market not reflected by the economy: “If I had constrained the stock market to what the economy had actually done, the S&P 500, you should know, would’ve peaked at 1,850, not 2,940. And the excess, that gap, is all about the excess Fed liquidity pumped into the system through artificially low interest rates and quantitative easing.”
The high, apparently healthy, numbers of the stock market index superficially conceal the relatively weaker health of the economy.
A bloating system
In addition to the artificial ballooning of the stock market, Rosenberg noted other trends that have strengthened his conviction of an economic slowdown.
In particular, he pointed to high corporate debt-to-GDP ratios. Such high leverage situations have often preceded recessions.
Focusing on corporate debt, Rosenberg emphasized that “we have never had a more junkier corporate bond market than we do today.” He added that even the quality of bonds is poor, with 50 per cent of investment grade bonds rated BBB. This is the lowest rating for an investment grade bond, with lower graded bonds classified as ‘junk’ and considered high-risk or speculative.
Rosenberg explained that the response to the current high leverage will be corporate deleveraging. This would in turn lead to recession because of the sacrifices in capital spending.
Recession is coming
Based on correlative analysis, Rosenberg presented a relationship between levels of employment and recession cycles. Low unemployment, as is currently the case, was often followed by recession and a shrinking job market, while high unemployment signified a potential for sustained growth.
“They call the unemployment rate a lagging indicator,” Rosenberg said. “I don’t think it’s a lagging indicator. It is actually a great recession indicator.”
In Rosenberg’s view, economic health markers are clearly trending in a downward direction. Yet some might argue that these are tenuous relationships with interrelated causes and effects, a classic case of the chicken and the egg.
As common wisdom goes, cycles end, bubbles burst, and a bull market transitions into a bear one. So when will this period of boom hit a dead end?
The answer, for Rosenberg, is that we might already be in it.