Saturday, May 23, 2009

David Rosenberg is trying to assess how a $20-trillion shock is going to influence the future

David Rosenberg' interview with Brian Milner:

You remain convinced that the U.S. is nowhere close to being out of the woods. Why is that?

We had three shocks in succession [in the U.S.]. We had a housing shock, followed by a credit shock, followed by an employment shock. Although credit conditions aren't back to normal ... there's no doubt that they are measurably better than they were just three to six months ago. But the other two shocks are lingering and still very significant.

You were predicting by 2005 that U.S. housing would take a serious tumble.

I had this bad gut feeling about home prices. I was early on the call. But you could see the cracks. We know that house price deflations don't end well. But this proved to be far worse than anything we saw in the 1990s.

Because you were an early bear at the table, plenty of smart portfolio managers dismissed what you had to say. Won't that happen again, now that the market seems to be bottoming out?

I know that people will say, well, there's the boy who cried wolf. And all I can say to that is: Remember, the wolf showed up at the end of the story.

I take it that U.S. housing remains the No. 1 concern.

It's hard to imagine that anything is going to stabilize until we put a floor under home prices. They are still declining to varying extents in most parts of the States.

What's critical in forecasting [the economic recovery] is trying to assess how a $20-trillion shock, which by the way is a 30-per-cent hit to the [U.S.] household balance sheet [on a par with what occurred in the 1930s], is going to influence the future.

This is very difficult to forecast. And there are long and insidious lags between a shock to the household balance sheet and the peak impact on consumer spending.

Why is that?

It takes time for households to determine if this is a permanent or temporary loss of wealth. If it's a temporary loss, there will be no impact on spending or the savings rate. If it's deemed to be permanent, then the impact is going to be significant, but it will happen quarters or years down the road. It takes a while for people to process.

So those predicting a turnaround by the end of this year are overly optimistic?

In a normal recession, we're off to the races by this stage of the cycle. But when you go back and take a look at other countries in other periods that also endured a credit contraction and asset deflation of this magnitude, the decline in GDP typically lasts two years, not 10 months.

And it takes six years for home prices to bottom out, and the unemployment rate typically rises over a four-year interval. There will be a time and place when we actually do put in that bottom. To think that it's going be this year is a little early.

You also point out that the average age of the consumer is also a big factor in crimping a consumer-led recovery.

We have the first consumer recession in the United States where the median age of the boomer is 52. The last time we had a [mild] consumer recession in 1990, the median boomer age was 34. They were still buying refrigerators and cars and microwave ovens. What's happening right now is that the boomer is going to his or her financial adviser and seeing two pieces of paper that scare them to death - their net worth statement and life expectancy table.

Let's turn to the other big shock, labour. You don't like what you see when you delve deep into the U.S. data, do you?

There are very disturbing trends. In lockstep with letting people go, companies have also been cutting people's hours at almost a record rate. The 33.2-hour [U.S. average] workweek is at a record low.

People don't look at that. But that is also a component of income. We have lost eight million full-time jobs in this recession.

In a normal recession, we'll lose 2.5 million. But not everybody was let go. Six million were. Two million were pushed into part-time work. The number of people working part-time and not by choice is up almost 80 per cent year over year. We have never seen a growth rate like that.

What does the dramatic increase portend?

The biggest effect is on income, which drives spending, which ultimately drives profits.

So I guess we should forget about consumer-related stocks for a while.

I still hear this from clients today: 'Don't count the U.S. consumer out. It never pays to underestimate the shopping prowess of the U.S. consumer.' I think people are still in denial. ... This is a new paradigm of frugality.

There has been a definite shift in psychology. So when you have [housing] affordability at record highs and very little thrust on home sales, there's valuable information there about the savings-spending relationship. It doesn't make you feel too good, admittedly.

People's attitudes towards credit, discretionary spending and home ownership have changed. This is going to take place over a period of years. To think that after eight months of a declining trend in consumer spending that this is over would be extremely hopeful.

So you would steer clear of consumer discretionary and housing stocks. What about U.S. financials?

What's the future business model? I would not be putting a large multiple on trading revenues. But they got dramatically oversold, and the Obama team did an excellent job in selling the stress test. But it's really hard to forecast the future in terms of what the structure's going to look like, how regulated they're going to be. What we do know is that the biggest client of the banks, which is the household sector, is going to be cutting back on credit. So it probably favors asset managers or those [other] parts of the financial sector that are geared toward savings.

Let's turn to Canada. Why so bullish on your homeland?

If you have the view, as I do, that Asia will come back first, then the implications for basic materials and industrials that are geared to that part of the world should be positive, at least in relative terms.

A third of the Canadian economy is devoted to the U.S. But that doesn't mean our market can't outperform. In fact, I think that it will because of the additional torque that we get from the push in the commodities sector.

Any more reasons to feel upbeat?

You don't have to do much more than take a cursory glance at the data to see that there are glaring differences [with the U.S.], that Canada is in much better shape.

How, ultimately, is that fiscal mess going to get cleaned up south of border? If you go back to the 1930s, you'll see that it was through relentless increases in marginal tax rates. That's going to work to our advantage.

I think that there's going to be a lot of money flowing into the Canadian capital markets in the next several years. It's very bullish for the Canadian dollar. ... Over time, Canada is going to be viewed as a bastion of stability.

You also say that Canadian fortunes depend on whether China's recovery story turns out to be real.

There's no doubt that our economy is very closely hitched to the U.S. market. But our stock market is actually very significantly tied to what happens in China, because roughly half is resource-oriented.

There's the old saying that in the land of the blind, the one-eyed man is king, and Canada is the one-eyed man, certainly relative to the U.S. If the story in China is the real deal, so much the better.


At a glance

Economist David Rosenberg, 48, started his first Bay Street job on Oct. 19, 1987 - one of the worst single days in stock market history.

Education: Bachelor and master of arts degrees from the University of Toronto


In 1987, four years after getting his start at Bank of Canada and Canada Mortgage and Housing Corp., leaves Ottawa for Bay Street and senior economics posts, first with Bank of Nova Scotia and then Nesbitt Burns.

In May, 2000, joins Merrill Lynch in Toronto as chief Canadian economist and strategist. In 2002, transfers to Wall Street as chief North American economist. Commutes to Toronto on weekends. Consistently ranked as one of the top economic analysts.

Jan. 1, 2009: Stays on after takeover of Merrill by Bank of America.

May, 2009: Moves back to Bay Street as chief economist and strategist with Gluskin Sheff + Associates.

Rosenberg has been recognized for his leadership and achievements in his field. He has ranked first in economics in the Brendan Wood International Survey for Canada for the past seven years. He was also on the U.S. Institutional Investors All American All star team for the last four years, placing second in the 2008 survey.

Notable quote

"What we know about periods of asset deflation and credit contraction is that the impact on the economy tends to last for years, not quarters."

(from Globe and Mail, May 20, 2009)

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