In his latest daily missive, Gluskin-Sheff's David Rosenberg lays out everything that should lead you to believe we're not in a garden-variety recession, however much traditional forecasters might think we are.
So, we had a huge bounce off the lows, but we had a similar bounce off the lows in 1930. The equity market was up something like 50% in the opening months of 1930, and while I am sure there was euphoria at the time that the worst of the recession and the contraction in credit was over, it’s interesting to see today that nobody talks about the great runup of 1930 even though it must have hurt not to have participated in that wonderful rally. Instead, when we talk about 1930 today, the images that are conjured up are hardly very joyous.
I’m not saying that we are into something that is entirely like the 1930s. But at the same time, we’re not in Kansas any more; if Kansas is the type of economic recoveries and market performances we came to understand in the context of a post-World War II era where we had a secular credit expansion, youthful boomers heading into their formative working and spending years and all the economic activity that went along with it, and periods when recessions were caused by excess inventories and overzealous central banks fighting inflation — a war that can always be won with traditional interest rate weapons.
Now we are in the process of unwinding the excesses of a parabolic credit cycle of the prior decade, the first of the boomers are now retiring with nobody around to buy their monster homes and the Fed is now fighting a deflation battle that is prompting comparisons to Japan for the past two decades. Moreover, here we have the Fed unexpectedly cutting its forecast for growth and inflation in the past month-and-change, and then we had Ben Bernnake tell us that the macro outlook is “unusually uncertain”. The world’s most important monetary authority, with all deference to the People’s Bank of China, is now openly contemplating more experimental quantitative easing measures to propel economic growth at a time when policy interest rates are zero, the size of the Fed’s balance sheet is already triple its normal size, at $2.3 trillion, and at a time when the budget deficit exceeds $1 trillion, or 10% of GDP, and there are cries now even from incumbent Democrat senators for Obama to extend the once vilified Bush tax cuts. You can’t make this stuff up.
So, how should you invest?
So the strategy is not to be “buy and hold”, but to navigate the portfolio in the context of a secular bear market with massive up and down moves. This is done by adopting hedging strategies that actually hedge and with a net short position because, make no mistake, we are still in the throes of a secular bear phase. There are actually ways to profit from this in effective long-short strategies.
Second, we are in a phase where deflation risks trump inflation risks, and this is not a case where cash is king — cash, by the way, has not been king in Japan either for the past two decades — but what is king in a deflationary cycle is income, no matter how you can secure it, whether through classic hybrid funds or through bonds. And, not just government bonds because in some cases, corporate balance sheets today are in better shape than government balance sheets — when I look at classic measures like debt-equity ratios, liquid asset ratios, debt maturity schedules and the ratio of long-term debt-to-total outstanding corporate debt, the corporate balance sheet is as good a shape as it has been in for the past 50 years, and this is coming from a renowned bear.
But corporate bonds are plays off the balance sheet whereas equities are a play off the income statement and I think the income statement, specifically corporate profits benchmarked against where investor expectations, are probably going to disappoint. I think that even if we manage to avert a double- dip recession, it probably won’t be by that much and right now the market is priced for 35% earnings growth in the coming year. That seems too high a hurdle at a time when margins have already expanded to cycle highs in a very short time frame.
The fact the equity markets stopped going up in April, despite how good second quarter earnings season was, is testament to the view that investors have only recently become a little squeamish over the outlook for corporate profits. Guidance has been decidedly mixed.
For corporate bonds, it comes down to credit quality and the ability to service debts. What some analyst at some Wall Street firm does to his or her earnings estimate for Company X, or if Company X issues a profit warning because of a weaker-than-expected economic backdrop, is more a problem for equities as an asset class than it is for corporate bonds. This is especially the case considering the record amount of cash sitting on corporate balance sheets because CEOs understand the economic risks much more than the economists, analysts, strategists and other talking heads you see on bubble-vision.
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