He is not sure when it will happen, but David Rosenberg is confident investors will face another big correction in the stock market.
Rosenberg spoke via webinar at the annual conference held by the Portfolio Management Association of Canada (PMAC). Rosenberg is the president, chief economist and strategist of Rosenberg Research & Associates, a firm he founded in 2019 after serving in similar strategist roles at Gluskin Sheff and Merrill Lynch.
A consensus view among Wall Street analysts is that, “We’re looking across the valley,” particularly following the encouraging announcements of vaccine results by Pfizer and Moderna.
But that valley has plenty of land mines, Rosenberg said.
He reminded the audience that the TARP 1 program, which was viewed as a rescue measure “across the valley” during the global financial crisis, was followed by a 30% correction. We could have a double-dip recession before the vaccine is deployed, he warned.
During all 11 post-war recessions, investors could see across similar valleys, he said, but there was always a 30% market correction. That happened despite the “famous selling lines” from the bulls, like “there is no alternative (TINA)” and there is a “ton of dry powder waiting to be deployed.”
Gridlock, especially if Republicans maintain control of the Senate, will increase the likelihood of a lack of fiscal stimulus and of another downturn. “This is a global economy with a fiscal addiction,” he said.
The virus is “out of control,” he said; hospitalizations are rising and the U.S. is facing widespread partial shutdowns. “We are not paying enough attention to the strain on the health system.” Since February, the U.S. has lost about 600,000 medical system workers, which he called “a complete travesty.” Many of those job losses were due to people leaving the workforce because they retired, were “burnt out” or needed to stay at home to care for family members.
A warning to value investors
If Rosenberg’s warnings about the economy and equities were not enough, he was even more cautious about value stocks.
He titled his talk, “Rule 1 Battles Rule 9,” in reference to Bob Farrell’s 10 rules of investing. Rule 1 is that markets revert to the mean over time, and rule 9 is that when the experts agree, something else is going to happen.
Investors expect value stocks to revert to the mean and end their decade-long underperformance relative to growth. That expectation is fueled by the price-to-book ratio of the Russell growth index being five times that of the value index, and its forward P/E ratio is two times that of growth. Growth is trading at its biggest premium over value since 2000, according to Rosenberg.
Indeed, he said the $7.6 trillion valuation of the FAANGs and Tesla is more than three times greater than that of the Canadian economy.
But the consensus, reinforced by every strategist, economist and analyst, is that investors should rotate from growth to value, according to Rosenberg.
Rosenberg favors rule 9 over rule 1. The consensus is wrong, and investors should favor growth stocks.
We should be concerned about valuations, he said, but ultra-low rates boost valuations of companies with far-off cash flows, like the growth stocks. “This is the dominant issue driving valuations.”
The growth-versus-value decision depends on the post-COVID world, but that world will be slow growth. “You want high-duration (growth) stocks,” he said. He called the decision to invest in value a “trade, not a trend.”
There will be in a prolonged period of very low inflation and low rates, Rosenberg said, because the output gap is the greatest since 2009, and will take at least three to four years to close. In that environment, investors should want dividend growth, dividend yield and hard assets that benefit from low rates.
The virus and politics
Rosenberg had mixed views on the path of the virus.
He called the test results for the vaccines a “gold standard,” and said that in six to 12 months we could inoculate the world.
But the markets are pricing in the best-case scenario. Be careful, because all economists had a vaccine in their forecast before those results were announced. “This moves the timing up three months,” he said. “The news is not enough on its own to generate a five-standard-deviation move up in equities,” in reference to the spike in U.S. stock prices in the last week.
In addition, we should be concerned about the logistics of vaccinating so many people, whether a mutation could occur (as happened in Denmark), or if there could be short-term weakness as people “hunker down” and hoard goods as they did at the start of the pandemic.
Rosenberg warned that vaccine optimism could reduce the urgency around extending fiscal support. But the U.S. election was good news on many fronts, he said, especially that Biden-Harris victory was not a vote for left-wing policies.
The most important man in Washington is Mitch McConnell, not Biden, and we won’t see tax cuts for at least two years. But nor will we see fiscal stimulus. The problem is that the global economy, except maybe China, cannot manage without what Rosenberg called “fiscal training wheels.”
The post-pandemic world
Bet heavily against things going back to normal, Rosenberg said.
What was “really amazing” was that more than half of U.S. households had only three months of savings prior to the pandemic, despite historically low unemployment. “The future will be one of treating savings as sacrosanct,” he said.
We will go back to normal in due course, he said, but there will be residuals. That will include a permanently higher equilibrium savings rate and a lower labor-force participation rate.
When we go back, it will be a low-growth, low-interest-rate environment. That will be driven by demographics, wealth inequality and a debt burden that was accentuated by the pandemic. “Debt will be a serious tourniquet on growth for a long time,” he said.
He said we are in a “depression,” because of the secular change in behavior, along with a prolonged period of subpar growth and deflationary pressure.
Global supply chains will shrink, with an emphasis on just-in-case instead of just-in-time inventories. He fears there will be permanent lifestyle changes. Among those will be the “Peloton effect,” where people will shift from using gyms to in-home exercise machines.
Investment ideas
Rosenberg’s favorite trade is the 30-year Treasury bond. It has a 1.7% yield at a time when global yields are close to zero. It and other bonds will continue to act as “ballast” and source of stability for the years ahead, he said.
The 60/40 portfolio is not dead, he said, but the argument for it is superfluous. “Investors should worry about minimizing their losses,” Rosenberg said, “especially in the world today, which has so much uncertainty.”
Interest rates are a price and are telling you that expected returns are extremely low. The Shiller CAPE ratio, at 31, is telling you that equity returns will be low. “We are heading to a world of zero-real returns,” he said, “but bonds are still valuable because of their certainty of payment.”
Gold was in a decade-long bull market before the pandemic. Its production rate is about 1%, while the global money supply is up about 20%, according to Rosenberg. “If central banks are at the center of policy,” he said, “then the inflation timetable is accelerated and gold is a perfect hedge against inflation and deflation.”
Read more articles by Robert Huebscher
