“We Are Late In The Game”: David Rosenberg On The Market's Flashing Red Signs
Last week, some readers were left wondering why, if the economy is as strong as the president is pretending it is (even though a leaked email from Donna Brazile revealed the truth behind the propaganda), did Gluskin Sheff strategist recommend unleashing a multi-trillion, “helicopter money” stimulus drop. The reason: we can officially close the book on the “bullish” Rosie and welcome back the old, grizzled, much more familiar version of the former Merril Lynch strategist: one bearish enough that the following litany of indicators that are “flashing red” for a late cycle economy, brings us back in time to some of his vintage pre-crisis writing.
Courtesy of the Financial Post, here is David Rosenberg explaining why “all signs are flashing this market is ‘late in the game’”
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Late in the game: that is precisely where we are. And it’s not even an opinion any more. It is a market fact.
The TSX has not made a new high in over two years and it has been 17 months for the broad NYSE Composite stock index.
The yield curve is flattening. Leading economic indicators are sputtering.
Uber-tight credit spreads and ultra-low cap rates in real estate serve as confirmations of late-cycle pricing.
Traditional valuation metrics for equities are every bit as high if not higher than they were in the Fall of 2007.
We are well past the peak in autos and just passed the peak of the housing cycle.
Not just that but the broad measures of unemployment have stopped going down as well.
And the mega Merger Mania we are seeing invariably takes place at or near cycle peaks, as companies realize that they can no longer grow their earnings organically. We have just witnessed five multi-billion dollar deals this past week alone — $207 billion globally (AT&T/Time Warner; TD Ameritrade/Scottrade) in what has been the most active announcement list since 1999 … what do you know, near the tail end of that tech bull market too.
We also were at the receiving end of a really disappointing consumer confidence report out of The Conference Board — sliding to a three-month low of 98.6 in October from 103.5 in September, the sharpest slide of the year.
And it wasn’t just the politics or gas prices — just a general malaise.
Assessments of business conditions now and perceptions for the next six months deteriorated significantly, as they did for the jobs market and spending intentions for homes and appliances.
This sentiment index generally peaks between 60% and 70% of the way through the cycle and so if that traditional pattern holds for this one, it would mean bracing for a recession to start any time from October 2017 to May 2018.
Forewarned is forearmed.
There also is this little issue of excess valuations, as in the 24x price-to-earnings multiple on reported GAAP earnings which is about 40% “rich” compared to the norm of the past 80 years.
On top of that, we have twice as many bulls as bears in the sentiment survey data.
That said, there is not the same level of euphoria as there usually is at the top of the market, and this is reflected by the wave of mutual fund redemption in equities for much of this year and the fact that global portfolio managers are sitting tied for the highest cash ratios of the past 15 years.
So while cautious, the lack of extreme bullishness is actually a good thing and suggests that whatever correction or even bear market we see, the selloff should be limited and no, it will not look anything like 2008/09.
That said, having cash on hand, reducing the beta of the portfolio, focusing on the running yield, and stepping up in quality across the capital structure, are all going to pay off in terms of preserving the capital and generating decent mid-single digit net returns at the very least. That’s with a view towards allocating the dry powder at better price levels that will allow for a return to high-single digit or even double-digit returns once the dust settles.
What is important to know is that the backdrop is one of late cycle. Most of the patterns, both in the realm of financial assets and the real economy, are flashing this signal — one of a very mature market.
Now, I am not sure if this is the seventh inning, or the ninth, but it is likely somewhere in between. That’s important to know — we are not in the third or fourth, let alone the first or second. And even in the seventh, we still have to get out of our seat and stretch.
That does not mean a stretch for risk — it actually means dialing in the risk, at the margin.
It isn’t just the valuations and the heightened political risks in the U.S. and throughout Europe, or the recent slate of soft macro data for the most part. It also is about what the corporate sector is flagging about how much more growth there is in this economic cycle, having celebrated its seventh birthday four months ago.
What I’m referring to specifically is Kimberly-Clark’s financial results for the latest quarter, which surprised to the downside and the company also cut its sales guidance for the year (for which the stock price was clocked with a 4.7% loss on the news).
So I have to say that if this classic consumer staple giant, who makes Huggies diapers and Kleenex tissue, can’t grow these basic goods, what does it say for consumer goods and services that are truly discretionary in nature?
This does not at all bode well for the coming holiday shopping season, and if you have looked at the payroll data in recent months, the retailers are expecting some nice tidings. They may be in for a rude surprise.
This is the environment where the Fed is choosing to raise rates, which is incredible. The futures market is still priced for a near-70% chance of a December move. The two-year U.S. Treasury note auction yesterday went quite poorly (the bid-cover of 2.53x was the second lowest since December 2008) and the yield backed up to a four-month high of 0.85%.
We’ll see how brave the Fed will be — we know what happened last year after the Fed went and for two or three months, it wasn’t a pretty picture.
Now New York Fed president Bill Dudley did say that he would like to raise rates again before year-end but caveated that with “… subject to the economy continuing to evolve in line with my expectations”.
Well, if his forecast is aligned with the median on the FOMC, then implicitly he is expecting 3% real GDP growth for the fourth quarter. Good luck with that (a number we have not seen materialize in two years).
One thing is certain: if the Fed does raise rates at the short end, we may well end up seeing yields decline further out the curve — as we did following last year’s rate hike.
Classic. This is what happens when the Fed starts to tighten into the eighth year of the cycle and into the slowest-growth-year of this elongated expansion.
We also have this ongoing “conundrum” (as Alan Greenspan once put it) of there being a global savings glut (at a time when the world’s central banks have taken $18 trillion of “safe yield” onto their balance sheets and out of the hands of the general investing public).
In fact, the authors of a report commissioned by the Council on Foreign Relations said that the global savings “glut” has reached epic proportions. The volume of inflow of savings from abroad into U.S. securities totalled an eye-popping $750 billion in the past two years — $500 billion of which was diverted to Treasuries and Agencies, as America played the role (and still does) as the world’s smartest kid in summer school when it comes to delivering positive yields on AAA-rated paper.
What this leaves us, therefore, is the prospect of a continued flattening of the yield curve. Again, classic late cycle development.
Now you will hear cries from many circles to ignore the yield curve, it has lost its edge as a leading indicator due to all sorts of reasons, mostly related to central bank interventions. Don’t believe them.
Back in 2000, the experts said to ignore the yield curve — it is irrelevant in a Dotcom world. Wrong.
In 2007, the gurus also said to ignore the yield curve in a world of abundant credit.
It still matters, and if we were to get the same response this time to the Fed as we did just over a year ago, we would then be two, maybe three more hikes away from a complete inversion of the Treasury curve.
Maybe it has lost some of its predictive power, but it has called each of the last 10 recessions of the post-World War Two period with precision. So I wouldn’t exactly abandon it just yet.
David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave. Follow David and his colleagues at twitter.com/gluskinsheffinc