David A. Rosenberg is Chief Economist & Strategist at Gluskin Sheff, with a focus on providing a top-down perspective to the Firm’s investment process. Mr. Rosenberg has earned both Bachelor of Arts and Master of Arts degrees in Economics from the University of Toronto. Prior to joining Gluskin Sheff, David was Chief North American Economist at Bank of America-Merrill Lynch in New York and prior thereto, he was a Senior Economist at BMO Nesbitt Burns and Bank of Nova Scotia. Mr. Rosenberg has ranked first in economics in the Brendan Wood International Survey for Canada for the past seven years and was on the U.S. Institutional Investor All American All Star Team for the last four years.





It’s that time of the year when ‘sell-side’ research departments publish their Year-Ahead Reports (as I once did in the not-too-distant past); as do all the financial magazines.

I realized after countless emails and phone conversations (in that order) that there is a very high expectation that I publish one too. I honestly have no intention of publishing a specific set of forecasts in my current role as the Chief Economist and Strategist for Gluskin Sheff for public consumption — the granularity of my recommendations is reserved for our Investment team and our client base. Be that as it may, I am more than happy to comment on what I see as an emerging consensus and my general view on the direction of the economy and the markets in the coming year without getting into too much detail or numerical forecasts, which are the domain of the ‘sell-side’ macro teams globally.

At the outset, let it be known that when I read everyone else’s year-ahead prognostications, all I can think of is, “where do I store this stuff for a year so I can look back and say ‘That was so wrong!’.” It’s not that the reports are always bullish every year; it is that they seem so contrived. And, as I mentioned in the December 10th edition of Breakfast with Dave, this year, probably like most years, there seems to be a remarkable level of agreement. Based on my reading, here is what I conclude the consensus views are as we head into 2010:

• Muted recovery, but positive growth, for sure! No risk of a ‘double dip’.
• Equity markets up!
• A barbell strategy of domestic multinational blue chips and emerging market equities.
• The U.S. dollar is…neutral, but we did locate more bulls than bears (so much for the ‘carry trade’ thesis).
• Positive on commodities for the most part.
• Concerned about government balance sheets, and therefore…
• …Bearish on long term government bonds because they are the ‘competition’ and, after all, who would tie their money up for 10 years at 3.5% when you can lose 22% in stocks? And, therefore…
• …Bullish on spread product (as long as it’s not long-term). And, therefore…
• …Really comfortable with high yield (just for the coupon and the view that default rates will come down).
• Certain that volatility will not be an impediment.
• The Fed will begin to raise rates in the second half of the year, but that this will have no impact since they will still be low.

So here we are with a glorious opportunity to reintroduce Bob Farrell’s Rule 8: “When all forecasts and experts agree, something else is going to happen.”

That being said, these economists and strategists, many of whom I know, are smart guys (and gals) and they are human. To ‘talk your book’ is human; to have the courage to ‘buck the consensus’ is divine. I too am human; I also like to feel that I have courage of my convictions; and I too have a “book” (of sorts — it’s called reputation). But I have decided to take the opportunity of the “Year-Ahead Moment” to transition from sell-side to buy-side and more importantly, to reflect on the past year and really try to prognosticate from the gut. You would be surprised how a blend of intuition and experience can make a difference in a cycle like the one we are in that has absolutely nothing in common with the other recessions of the post-WWII era.

Forecasting is a humbling profession even in the best of times and I have learned a lot in the past year, especially from my partners here at Gluskin Sheff who realizes all too well that:

1. It is what is embedded in asset prices benchmarked against the forecast that is of utmost importance for investors;

2. The focus of any forecast must take into account the reality that minimizing portfolio risks is at least as critical as maximizing the returns,

3. Every forecast has an error term and the range around any projection in a post-bubble credit collapse can be extremely wide.

I do not view the economic events of the last two years as a classic recession/recovery phase. They only exist in the context of a secular credit expansions and contractions. We are in a post-credit bubble credit collapse that is ongoing, à la Bob Farrell’s Rule 4: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”

Mainstream economists called this downturn “The Great Recession”. This is truly a gentle way of saying “Depression”. When we can have the courage to come to grips with the fact that we did in fact experience a depression of sorts, which is by definition a credit event, then and only then can we draw a conclusion that a sustainable recovery will not get underway until the ratio of household credit to personal disposable income reverts to the mean (and goes to an excess in the opposite direction). I know it sounds harsh, but we shall endure — believe it. Transition is rarely without pain.

The ratio of household debt to disposable income is up from a 30% ratio back in the 1950s to 125% today (though down from 139% at the peak in 2007). Mean reverting to a ratio closer to 60% means that the deleveraging process will be a multi-year event and by the time it is over, more than $7 trillion in additional household credit will have to be extinguished. For more on this see the unbelievably grotesque article on the front page of last Thursday’s (December 10) Wall Street Journal — The New American Dream.

Perhaps inflation is a consensus forecast but deflation is the present day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years. The fact that China’s voracious appetite for basic materials will continue to exert upward pressure on commodity prices does not detract from this view, especially given the widespread excess capacity in the manufacturing sector and the new frugality that has gripped, and in many cases, been embraced by the retail sector. Higher raw material prices, owing to developments in Asia as opposed to demand pressures here at home, will prove to be a sustained source of profit margin compression for many sectors and companies linked to finished consumer goods and services.

So, much of what I have read in various Year-Ahead Reports predict corporate earnings, GDP growth here and abroad, interest rates and relative values of currencies. As I mentioned earlier, the error term is bound to be very wide in this new paradigm (since WWII) of a secular credit collapse. GDP growth in 1934 was 10%, but the Depression wasn’t over until 1940.

Since 1989, the Japanese stock market has had no fewer than four 50%-plus rallies and there still has been no period of growth that can be called a sustained expansion. Today, we have our own special set of conditions and it is bound to be tricky as is typical during a post-bubble credit collapse, no matter how intense the government reaction. Prematurely committing to the ‘risk’ trade is probably going to be the most lamentable action over the next few years.

Suffice it to say, we believe that the dominant focus will be on capital preservation and income orientation, whether that be in bonds, hybrids, hedge fund strategies, and a consistent focus on reliable dividend growth and dividend yield would seem to be in order. To reiterate, I see the range of outcomes in the financial markets and the economy to be extremely wide at the current time.

But one conclusion I think we can agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive such, as in fixed-income and in equity sectors that lever off the commodity sector.

This, in turn, underscores my primary focus of favouring Canadian dollar based investments over the U.S. because at no time in my professional life have the downside risks — economic, fiscal, financial and political — been so low on a relative basis and the upside potential so high as is the case today. The near-2,000 basis point gap this year between the TSX and the S&P 500 — the former leading — should be taken in the context of being just past the halfway point of a secular (ie, 16-18 year) period of outperformance. Northern exposure never felt this hot.

Category: Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

One Response to “Year Ahead: Can You Handle the Truth?”

  1. bruerr says:

    My prediction for 2010: The news anchors on CNBC will unexpectedly short circuit like stepford wifes, and get stuck repeating “Its a jobless recovery. Its a jobless recovery.” Over and over again, and it will cause a massive sell off, as investors everywhere, realize they have been getting their live news feeds from pre-programmed robots.

    Bumping into each other. “Its a jobless recovery. Its a jobless recovery.” Three days of the same programming. Complete with panicky news editors, caught on film trying to readjust their arms. One of them on a cell phone, “but Lloyd, we already hit the reset button”… “Hit it again?” ….they stop and look at each other and then they too short circuit with small fire burning from behind ear piece.

    Everybody will wonder if this is what it feels like, being one of the sucker clients for GS or Bear Sterns.

    - – - -

    Other than that, I think items you mention Dave, are more on the level than a lot of the things market optimists have been blubbering on about lately. None of them ever mention the caveat (or asterisk type statement) with their optimism, about how at the bottom of this so called “rally” our government leaders determined to make material changes in accounting methods. Frankly such a rally based off a tweaking in accounting methods, used to rally the market so that (LETS NOT FORGET) banks could sell shares and raise capital (when no one else in the world economy trusted them enough to lend to them or invest in them) … is not something to be that optimistic about. Add to that, the whole thing was set to dance, in step, with a couple trillion in “off-balance sheet” transactions, circumvented around Congressional approval, and it would seem a more prudent and intelligent people would question the actions, than celebrate them. That so many are not raising up sustained questions, and expressing some disappointment about this model, is in imo, more a negative than it is a positive.

    Defining two encampment: Such wide spread omission, with optimism, is not as good as, as omission, with a pessimistic view attached. I do not like omissions of this size, with any outlook on the economy, but the pessimistic view does seem more prudent, in light of widespread omission from both encampments.

    - – - -

    Yes, more on the level Dave. I especially found myself rereading this part: “The ratio of household debt to disposable income is up from a 30% ratio back in the 1950s to 125% today…. Mean reverting to a ratio closer to 60% means that the deleveraging process will be a multi-year event and by the time it is over, more than $7 trillion in additional household credit will have to be extinguished.”

    7 Trillion is not trivial. Now add some of those accounting changes back into consideration. And Fed’s unwillingness to make disclosure about some of its lending, going back as far as August, Sept, Oct and November 2008. Say nothing about what they were doing in 2009. Add to that the idea floating around think-tanks in D.C. that Fed should incorporate military-grade secrecy about who its chosen business partners are. It just seems to me like a recipe “on how” to destroy confidence, than restore it.

    Whoever is writing the mantra for wall street these days (jobless recovery and confidence being restored), seems a bit touched with what psychological profilers might call, the same type of profile or pathology as a compulsive liar.

    Our government acts like Americans have never know a pathological liar; and like they have no real life experience to draw on when making their own conclusions on how to categorize what such a person or entity might say, to continue promulgating illusion/dilution.

    Now add to all this in reminder, that not many optimists are invoking their duty to inform the public, as custodians of other people’s money, that U.S. government has made material changes in accounting, which are in violation of standing law. This is an important asterisks* to be leaving out of a review of where we have been and where we are going imo.

    *legal reference: