David Rosenberg: Where to Go For Positive Returns

Monday, July 23rd, 2012

 

 
David Rosenberg discusses how the 3 D’s (Deleveraging, Deflation, and Demographics) are hurting markets, and where investors can go for positive returns, with Wealthtrack’s Consuelo Mack.

Here is the full transcript:

CONSUELO MACK: This week on WealthTrack, the influential economist whose projections have been right on target. Financial Thought Leader David Rosenberg shows how the 3 D’s of deleveraging, deflation and demographics are hurting economies and markets and where investors can go for positive returns, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. This week, we are sitting down for an in-depth interview with one of the handful of prognosticators who has gotten it right going into and through the rolling global financial crisis we are experiencing to this day. He is Financial Thought Leader David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff. Dave returned to his native Canada in 2009 after spending many years as Chief North American Economist at Merrill Lynch, where Institutional Investor magazine placed him on their coveted “All American All Star Team” from 2005-2008.

Rosenberg took on the bullish Wall Street herd as early as 2004, when he started warning about the developing housing and credit bubble which, as he predicted throughout, would wreak havoc on the financial system and many world economies. Well he hit the nail on the head again last year, forecasting the global economy would slow and that treasury bond yields would fall- another homerun. In his influential and widely read daily “Breakfast With Dave” reports, he ranges across the globe covering everything from Europe and how “it is rather incredible that this rolling crisis is now going on 2-1/2 years and policy makers have yet to find a viable solution”; to emerging markets and “why the once mighty BRIC currencies are depreciating of late at their fastest pace since the 1998 Asian crisis”; to the financial markets and “how the “pattern of the past three years is unmistakable as each spring, the equity market corrected as stimulus measures wore off, to only then prompt more incursions by the fall.”

What other patterns are unmistakable to Dave Rosenberg and why did he write in a recent report that “the future is brighter than you think”? I asked him all of the above and more, starting with what he thinks the most important patterns for the economy and markets.

DAVID ROSENBERG: I think the primary trend is still one of deleveraging. It hasn’t really changed much from the last time that the two of us spoke; it’s become much more global in nature. So it started off in the U.S. four or five years ago, in the American mortgage market, the housing market, consumer loans in general, but now we’re seeing how it’s morphed into the survival of the welfare state and all the debt finance to prop up these peripheral countries in Europe, and even now there’s questions about whether China is going to have a hard or soft landing because of a perceived property bubble there.

So we’re still in this deleveraging cycle, still dealing with the impact of too much debt relative to the size of the global economy, and this is what’s creating all this market angst and instability that we’re still living with; notwithstanding the fact that the economy, the U.S. economy is three years in a recovery, we’re still stuck in a very slow growth mode, but recurring financial market instability at the same time.

CONSUELO MACK: So is there any way of knowing whether the second half is going to be worse, better, or the same as the first half? Because, I mean, I’m thinking of my audience out there, and myself included, and saying, “I don’t want to live through another three or four years like this.” So what’s it going to look like, do you think the second half?

DAVID ROSENBERG: Well, I’m going to sound like a classic economist here and say it’s going to be somewhere in between, and this is what I mean. Are we going to get another gut wrenching, you know, 7% decline in GDP, and lose another 8 million jobs? I don’t think we’re going to go through anything close to what we endured in ’08 and ’09.

CONSUELO MACK: And to back-to-back kind of 50% decline in the stock market?

DAVID ROSENBERG: It’s not going to be that bad. But then again, you have to take a look at the contours of the recovery. I actually think the recovery tells you a lot more than the actual gut-wrenching recession did, because normally when you do this with the economy, you do that.

CONSUELO MACK: You get to a V, right?

DAVID ROSENBERG: Well, even in that 1933-’36 period, you got a huge recovery, much bigger than we had this time around, and this time around we had basically a checkmark of left-hand person, that’s what we had. It was not a V-shaped recovery; it was a very meager recovery, especially when you consider everything that the government threw at this thing. Consider the Fed took rates to 0 in December of ’08, they’ve tripled the size of their balance sheet $3 trillion. We’ve had, what, $4 trillion, four years of trillion-dollar deficits, and…

CONSUELO MACK: The fiscal stimulus…

DAVID ROSENBERG: …and more foreclosure moratoria. We’ve tried everything. So we’ve had modest economic growth, but very unacceptable. And now what’s happening is the Fed is left now with all these uncreative tools. Like Ben Bernanke certainly believes that he can do more but, you know, in Economics 101 you learn about the law of diminishing returns, and it’s basically that you end up getting less and less and less incremental impact from the same policies over time. And so that was the same with QE1, QE2, with the LTRO that we had out of Europe. We were getting just a smaller incremental impact on the economy with each individual policy proposal.

CONSUELO MACK: So therefore three years into a quote, unquote “recovery”, so are we on the cusp of another recession?

DAVID ROSENBERG: Cusp or precipice, I don’t know if I’m quite there yet. The economy is extremely fragile. The underlying trend in the economy is barely 2%, it’s barely 2%. So when you have a trade shock that can wipe out 2 percentage points of growth, you’re left with 0. Now, maybe that’s not a recession in the classical sense because we’re not actually going in reverse, but the unemployment rate is going up in a no-growth environment. And then you talk about this so-called fiscal drag, this fiscal cliff that we’re going to see next year- it’s because, you know, we’re probably not in as bad as shape as the Europeans, but here in America, we’ve kicked the can down the road a lot in terms of the Bush tax cuts getting extended, in terms of payroll tax relief, extended unemployment insurance benefits, all these provisions expire December 31st. So just by the government taking back the parking permit from everybody, we have a drag on the economy next year from fiscal restraint, 4 percentage points of GDP, percentage points.

CONSUELO MACK: Which we don’t have. So listening to you, Dave, quite honestly, I do want to kind of bury my head in the sand and I’m thinking to myself, you know, that I want to be in incredibly safe assets, that this is no time to put risk on. And yet, you know, one of the things that you follow, as well, is investor sentiment and the fact that there is a growing despair out there that people are very frightened and worried. And as we know traditionally, that’s in fact, the time when it’s actually best to buy risk.

DAVID ROSENBERG: I mean, there are always opportunities. In a fat-tail world, you’ve got to be very cognizant of the risks. So it’s as much not just focusing on the gross returns, but we have to – and this is what we’re doing every day at my shop at Gluskin Sheff- is we are assessing the risk, identifying it, managing it, and pricing it. And frankly it’s not about, you know, being risk averse. You know, people think that somehow, you know, when you talk about risk all the time you’re risk averse. It’s always important to make sure as an investor that you’re getting paid to take on the risk, that you’re not paying…

CONSUELO MACK: Right, so it’s price is really…

DAVID ROSENBERG: Right. Like, for example, I would say, you know, the high-yield bond market right now is actually, I would argue, priced for a bad economic outcome. You want to buy the assets that you think have already discounted. What’s embedded, what’s the story in this particular asset class, what’s it telling you? So I’m taking a look at the high-yield market right now. I think it’s actually very attractive. We have a core portfolio of high-yield bonds, and the reason I say that is because ultimately when you’re buying corporate bonds, you’re staking a claim in the corporate balance sheet. And the one thing that’s not changed, despite the fact that we’ve got all this angst overseas, the fact that the U.S. economy has hit stall speed, corporate default rates are barely more than 2%, you’ve got corporate balance sheets in great shape whether you look at debt equity ratios, or interest coverage ratios- the fact that treasurers companies both Canada in the U.S. have locked in their maturity schedules, 80% of corporate debt is locked in. In some sense, the corporate sector is in better financial shape than the government sector is. So I like corporate bonds.

CONSUELO MACK: One of the things that you’ve told clients is that reliance and deriving a stable income stream while preserving capital is paramount right now. So in these uncertain times, stability of income stream is one of your major investment focuses.

DAVID ROSENBERG: Right. And it comes down to what my overall theme is called: the macro and market outlook in 3D. So I’m talking about the 3Ds. What are the 3Ds? Well, they’re deflation, there’s demographics, and there is deleveraging and we talked about the deleveraging. There’s also this demographic overlay because the first of the Boomers are 55 going on 56, that’s the median age. The first of the Boomers are in their mid-60s, and so they control the wealth. They’re in a different part of their investment life cycle right now, and so accumulating cash flows as opposed to relying on strictly capital appreciation for the Boomer class, the life cycles as far as investments are concerned, that’s altered. And we’re seeing it in our own business in terms of what our clients are telling us, how they would like their money managed.

So you’ve got the demographics talking about the deleveraging, but the deflation. And so people will say to me, “Well, I thought in a deflation, cash is king in a deflation.” And the answer is well, you know, historically that’s true. That’s the ultimate capital preservation- cash is king in deflationary environment except when interest rates are 0. And so then it’s not cash is king, cash flow is king. So it’s imperative. It’s not just about preservation of capital, which of course in the fat-tail world, which is the deleveraging world, capital preservation is key; but you have to overlay that with preservation of cash flows. That’s why MLPs have been so popular.

CONSUELO MACK: Right, Master Limited Partnerships.

DAVID ROSENBERG: That’s why muni funds. That’s right, and that’s why REITs, and that’s why dividend growth, dividend yield have been so popular now. People come back and say to me, “But these things look so expensive.” Well, they look expensive because that’s what’s in demand, you know? And it doesn’t mean because it’s expensive you don’t want to buy it. You know, the perfume I bought is expensive, yeah, but is it good? Yes. Well, okay, that’s why it’s expensive because it’s a good thing to buy. These are good strategies right now, and that’s why their prices have been up as much as they have.

CONSUELO MACK: So as far as this pattern that we’ve seen for the past three years in the stock market, and where it rallies until the spring and then it basically sells off. That has been very disheartening for investors. Are we locked into that for the foreseeable future?

DAVID ROSENBERG: I think what we have is this battle going on, got this battle. We have the secular forces of deflation coming from all this deleveraging and the deleveraging, of course, takes demand out of the global economy, you’ve got the deflation, and then you’ve got these governments fighting it hard. So the secular forces of deflation in the market place, and then the tug-of-war as governments come in and reflate- whether it’s China, or whether it’s the U.S. government, or whether it’s the ECB. And so what this does is creates tremendous volatility, tremendous volatility.

But once again, the question is for an investor, what do I do with this volatility? How can I sleep at night? And that’s why in conjunction with say income equity over here, and corporate bonds over there, there should be a slice in the portfolio in hedge funds that really hedge long-short strategies that can actually be…

CONSUELO MACK: And they exist? There really are hedge funds that really hedge?

DAVID ROSENBERG: Well, you know, hedge funds have been around for 50 years. They got a bad name in the last cycle because they weren’t hedge funds, they were leverage long-only funds. But there are firms out there that are either hedge funds. You know, Gluskin Sheff is not a hedge fund, but 20% of our business is managing these long-short strategies, and it’s actually a very effective way to be nimble in the market place when you get these dislocations.

It’s really just taking sectors and companies that you think are bad businesses, are going to cut their dividends, and you put a short position on them, and you couple that with long position of the companies that you think are going to grow the dividends over time.

CONSUELO MACK: So let’s talk about earnings, because I know that you’ve said that the E in the price earnings ratio, the earnings, they are problematical. So what is your outlook for corporate earnings? And again, what does that mean for the stock market?

DAVID ROSENBERG: Well, corporate earnings right now have hit an inflection point, and it’s not just that they’re slowing, they’re actually starting to contract. Earnings are actually, after a three-year period of steady increases off those lows in 2009, corporate profits are actually now starting to decline outright.

CONSUELO MACK: And you’re talking about the S&P 500?

DAVID ROSENBERG: S&P 500 and even bigger picture. When we got the GDP numbers a couple of weeks ago- the GDP numbers give you corporate earnings for all of America, not just for the large-cap companies- and corporate earnings are coming down. And my sense is that the earnings estimates by the analysts on Wall Street is still far too high. Earnings estimates are important. I’m noticing that fewer companies are giving guidance. Fewer companies are giving guidance. What’s that telling you? That corporate CEOs, very similarly, they have a very clouded crystal ball right now. Fewer companies are giving guidance, and then the ones that are giving guidance, for every one that’s saying something positive about their business, two to three are saying something negative about what the outlook is. And on top of that, the estimates are starting to come down. I don’t think they’ve come down enough.

What does it mean for the stock market? You know, I think that if we were to go into a recession, normally the market corrects 20%. I’m not going to say that we’re going into a recession, but my sense is that the stock market is going to remain at best in the range that it’s been in for the past several months. We have to respect the range, but we’re going to be still in for a lot of volatility, which is why I was saying before that hedge funds, they really hedged, totally appropriate. On top of that, you have to be nimble and as tactical as you possibly can be, but if you’re going to ask me do I think that there’s more downside pressure given the risks out there, and especially to corporate earnings, the answer is yes. I think at this stage, without getting into, you know, what’s your call on where we can get to, I think the balance of risks is at that the market goes down over the near term and then goes up. And if it does, I think it will be a great buying opportunity down the road.

CONSUELO MACK: Let me ask you just about another macro issue, which is what about Europe? And you’ve said, you wrote recently that, you know, you’re two and a half years in, you know, these rolling problems keep coming up in Europe, and there are no viable solutions.

DAVID ROSENBERG: Well, I mean, there are solutions. I don’t know how viable they are. I think it’s a matter of just looking at it realistically. The European Union was working just fine. You know, the whole notion that we were going to try and avoid another World War, another European war at all costs. I don’t think that we needed to have a currency union to achieve that. You can’t have a monetary union and not have the fiscal union, and an integrated banking union. You can’t have it.

CONSUELO MACK: So realistically, I mean, are the 17 countries going to sacrifice their sovereignty?

DAVID ROSENBERG: Hardly likely. I had breakfast recently with a CEO of a major Canadian bank, and he told me that they have a Eurozone breakup committee. And he said this is happening around the world. Any major multinational corporation, any business that is doing business in Europe has one of these Eurozone breakup committees, not unlike the pre-Y2K committees that you had in the late 1990s. So you can bet your bottom Euro that if that’s what they’re doing, the Eurocrats in Brussels are trying to come up with some sort of… you talk about viable, what’s a viable exit strategy? Unless the ECB steps up en masse and rapidly expands its balance sheet, and starts buying the bonds of Italy and Spain en masse at auction, you know, that’s pretty radical. I don’t know what the quick fix is. So I think that the end game will ultimately be that the Eurozone breaks up.

CONSUELO MACK: One of your investment themes that we’ve talked about basically has been capital preservation and income orientation, as well, and one of the themes that you and I have talked about in the past is what you call “SIRP”, which is Safety and Income at a Reasonable Price. Are you looking for SIRP investments? Is that still a major strategy theme?

DAVID ROSENBERG: I would say that SIRP has its thumbprints across all the portfolios we’re running at Gluskin Sheff. In fact, what’s interesting is that we, for years, since 2001 we’re running this one particular strategy that’s called “premium income”, which it’s a hybrid, it’s got dividends, and it could have REITs, it could have preferred, convertible bonds; it’s really a portfolio aimed at distribution, a portfolio aimed at generating monthly cash flows for our clients.

CONSUELO MACK: And that’s Safety and Income at a Reasonable Price.

DAVID ROSENBERG: Right. Well, when we say… for example, when I talked about corporate bonds, and we’re talking about “safety” in quotes; I mean, safety, it’s relative. When talking about corporate bonds, it’s because of the quality of the balance sheets are very strong. Because that’s inherently when you’re buying corporate bonds, it’s mostly about default risk. You want to minimize that strong balance sheets. When I talk about on the equity side, we’re talking about running portfolios that have a low beta, which means low correlations with the overall market direction.

CONSUELO MACK: Right. The overall stock market direction.

DAVID ROSENBERG: The overall stock market direction, so we’re talking about, so it’s not just about, you know, does this company have a consistent history of paying off dividends, and we like the business. It’s also how does it move relative to the overall market? So in a period like this where it’s very tumultuous, and where the market is more prone to go down than up, you want to run your portfolios with very low betas. And so that’s the safety part, that’s the “S” part of the SIRP.

CONSUELO MACK: And the low correlations of the markets, in a highly correlated market, which is what we’ve been in for the last several years, so what are the areas that aren’t correlated that have low betas?

DAVID ROSENBERG: Well, for example, one of the themes that we liked has been the consumer frugality theme. So it means consignment stores, it means private label, it means do-it-yourselfers. I mean, for example, you could actually say, wow, because a Home Depot, does it fall under that category as an example. I’m not going to go sell my home, I’m not going to move, I’m underwater in my mortgage, but you know what? I still want to have a fun life, so instead of buying a new home, I’ll spruce up my existing home. And so home repair, a do-it-yourselfer, and so you can find…

CONSUELO MACK: So can you match a name or two to, you know, the frugality theme? So, for instance, frugality, what’s a–

DAVID ROSENBERG: Well, I’ll tell you one area where we have been long, and it’s worked out well has been the dollar stores. And they’ve been phenomenal investments, and by the way, it’s not just because low income households shop there, you’d find… and what the studies are showing is that a greater share of middle income households are actually going to dollar stores. And that’s an area where we have focused on in terms of our consumer exposure.

CONSUELO MACK: Let me run down a couple of the other investment themes, noncyclical. So give me, you know, what’s the theory behind the noncyclical emphasis? And give me an idea.

DAVID ROSENBERG: Well, it’s all about generating stable cash flows. In an uncertain environment, what do you want in an uncertain environment? You want stability. What about utilities, regulated utilities? Regulated utilities. They have regulated pricing power. What about telecom? And it might not just be the stock, you might want to buy the bonds of these companies. Once again, if you have a single A telecom company that’s giving you a triple B yield, you know, I will be happy to take that all day long in terms of looking at the risk and reward. So telecom, utilities, consumer staples, these are the areas that will tend to outperform in the environment that I’m describing right now.

CONSUELO MACK: And one other category that you had was hard assets. So what are we talking about when you’re emphasizing hard assets?

DAVID ROSENBERG: Resources are not a bad place to be. They’re already corrected quite a bit, so resources, whether it’s raw food, or whether it’s, I would say energy, which is corrected quite a bit. ]If you’re a long-term investor, these are complements. They’re not going to generate a yield for you, but they are what you want to own, things you can see, touch and feel in a very uncertain world, and these things have cheapened up quite a bit, as a hedge against the income part of the portfolio.

CONSUELO MACK: So one question is One Investment for long-term to diversify portfolio, what is it that you would recommend that we all own some of?

DAVID ROSENBERG: Well, I’m still a big advocate of corporate bonds. As I said, I think balance sheets are in great shape, default rates are low, there is too much default risk priced in, and so I would say I would focus on, let’s try and generate equity-like returns without taking on the equity risk. And there is a part of the capital structure that can accomplish that, and it’s called “corporate credit”. That is still to me a happy medium between 0 percent treasury bills and going out in the riskiest part of the equity structure. So corporate bonds to me are a solid investment.

CONSUELO MACK: And Dave Rosenberg, you know, you have a reputation of being a permabear, which is not fair, because you were also known as a permabull in the ‘80s and the ‘90s, and in a recent report you said” the future is brighter than you think.” Why when others are despairing are you getting enthusiastic about the future?

DAVID ROSENBERG: Well, I’m not going to say I’m getting enthusiastic about the future. What I am willing to do is put out some checkmarks as to what can cause me to turn more optimistic. And so I see a flicker of light, and it’s realization that politics will lead the financial markets, which will lead the economy, and what leads the politics is the grassroots level, and so what happened last month, for example, I think in Wisconsin with the recall in San Jose, San Diego, and there seems to be this growing realization at the grassroots level that we have to get our public sector balance sheets in better shape; that these underfunded liabilities have to come under control. So we’re starting to see more of a groundswell of support.

What I’m thinking about is how things will change politically on November the 6th, understanding, coming from Canada; Canada went through what Europe is going through right now. Canada is going through what the U.S. was going through back in the early 1990s. You could never have predicted that Canada ten years later would be the poster child for fiscal integrity globally. But it took tremendous political courage.

CONSUELO MACK: We’ll see what happens, and that’s what you’re going to be watching, Dave Rosenberg.

DAVID ROSENBERG: I’m more than willing to reclaim my status of a permabull that I had in the ‘80s and ‘90s if I see those clouds part come November.

CONSUELO MACK: All right, Dave Rosenberg, so great to have you here from Canada, Gluskin Sheff. It always a pleasure to have you on WealthTrack.

DAVID ROSENBERG: Thank you.

CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s reiterates one we just talked about- Dave Rosenberg’s long-time income generating strategies which is S.I.R.P.: safety and income at a reasonable price. So this week’s Action Point is: seek safety and income at a reasonable price, or S.I.R.P.!

Everything we know about the financial markets right now points to ongoing volatility and headwinds for stock price appreciation. Among the areas Rosenberg recommends where you can find reliable dividend growth and dividend yields are: Canadian and U.S. preferred stock shares, which are senior to common stocks; energy infrastructure investments, such as natural gas pipelines; and utilities. All S.I.R.P. vehicles.

And that concludes this edition of WealthTrack. I hope you can join us next week. We are going to sit down with an investment professional who combines two disciplines: overall investment strategy and actual fund management. BlackRock consultant Bob Doll will join us to discuss macro trends and micro strategies. Until then, to see this program again, or others and read my Action Points and our guests’ One Investment recommendations, please visit our website, wealthtrack.com Have a great weekend and make the week ahead a productive one.

Tags: American Economist, Chief Economist, Consuelo Mack, Credit Bubble, David Rosenberg, Deflation, Demographics, Depth Interview, Global Economy, Global Financial Crisis, Institutional Investor Magazine, Investors, Merrill Lynch, Native Canada, Prognosticators, Sheff, Target, Treasury Bond Yields, Viable Solution, Wealth Management Firm, Wealthtrack, World Economies
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World’s Biggest Economies Face $7.6T Debt Led by Japan $3 trillion, U.S. $2.8 trillion; Rollover Problems in Japan and Europe

Wednesday, January 4th, 2012

With everyone watching debt rollovers in Europe, let’s instead take a look at the total global debt rollover and debt issuance problem.

Bloomberg reports World’s Biggest Economies Face $7.6T Debt

Governments of the world’s leading economies have more than $7.6 trillion of debt maturing this year, with most facing a rise in borrowing costs.

Led by Japan’s $3 trillion and the U.S.’s $2.8 trillion, the amount coming due for the Group of Seven nations and Brazil, Russia, India and China is up from $7.4 trillion at this time last year, according to data compiled by Bloomberg.

The amount needing to be refinanced rises to more than $8 trillion when interest payments are included. Coming after a year in which Standard & Poor’s cut the U.S.’s rating to AA+ from AAA and put 15 European nations on notice for possible downgrades, the competition to find buyers is heating up.

2012 Debt Rollovers and Interest Payments

Japan’s Problem

Remarkably, rolling over US debt is unlikely to be a problem. The same cannot be said for Japan. Because of demographics, pension plans will be net sellers of Japanese bonds. Unless balance of trade or tax revenues increase enough in 2012 Japan will not be able to roll this debt over at 1%. A rise to 3% would consume nearly all of Japanese revenues.

Europe’s Problem

The ECB elected to kick the can down the road with a 3-year long-term refinance operation (LTRO).

For example, please consider Spanish banks use ECB cash to cover maturing debt-sources

MADRID, Dec 22 (Reuters) – Spanish banks will use the majority of the cheap long-term cash from the European Central Bank to cover steep 2012 debt maturities, market and banking sources said on Thursday.

Spain’s banks face a massive spike in their funding needs next year with around 130 billion euros ($170 billion) of debt coming to maturity. Many banks took on 3-year, government-guaranteed debt in 2008, making up a large part of borrowing.

“The banks that have taken part in the auction have primarily done so to finance the hefty maturities that fall next year, mostly in the first half,” said one savings bank source.

Also consider Italy banks almost halfway to 2012 funding needs

MILAN, Dec 22 (Reuters) – Italy’s banks are almost halfway towards meeting their funding needs for 2012 after they tapped 116 billion euros of cheap long-term cash from the European Central Bank on Wednesday.

The ECB’s first ever offer of three-year loans on Wednesday drew heavy demand of 489 billion euros from 523 banks, raising hopes a credit crunch can be avoided and that the money could be used to buy Italian and Spanish bonds.

The ECB will follow up with another similar operation in February in a move designed to directly help banks which need to raise capital.

A study by local broker Intermonte said 42-44 percent of total Italian bank funding and 75-80 percent of wholesale funding for next year had been raised on Wednesday.

The euro zone banks also have about 920 billion euros of liquidity existing with the ECB which indicates Italian banks could have some 230 billion.

On top of this are funds the banks can raise through the wide range of cash operations offered by the ECB.

Dollar Swaps Soar

That “wide range of cash options” no doubt includes the fact that European banks can borrow money from the Fed at a cheaper rate than US banks can. Please consider Demand for Dollars from Fed’s Discount Window Swells in Europe by 12,735% After Fed Cut Rates on Dollar Swap Lines

There is considerable debate as to whether European banks are using cash from the ECB to purchase sovereign debt and capitalize on massive spreads but Italian banks deny the charge as noted by this clip from Reuters:

There is speculation that some banks will use the ECB funds not to boost the real economy but for carry trades on investment in high-yielding government bonds. “We intend to support the real economy as far as is possible given the stiff ties imposed by EBA,” the CEO of UBI Banca Victor Massiah told Reuters.”

There is also debate as to whether or not the LTRO can stop contagion. For a detailed discussion, please consider European Bank-to-Bank Lending Mistrust Hits Second Consecutive High; ECB’s LTRO Won’t Stop Collateral Contagion.

For now, massive Fed dollar swaps coupled with the ECB’s first ever 3-year LTRO have temporarily calmed European debt markets, how long that lasts remains to be seen.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Aaa, Balance Of Trade, Bloomberg, Bond Bill, Coupon Payments, Debt Issuance, Demographics, Downgrades, ECB, Global Debt, Governments Of The World, Interest Payments, Pension Plans, Redemptions, Rollover Problems, Rollovers, Seven Nations, Spanish Banks, Tax Revenues, Trillion
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Arnott: Look Outside Mainstream Stocks and Bonds (Morningstar)

Wednesday, September 28th, 2011

Arnott: Look Outside Mainstream Stocks and Bonds
Investors need to broaden their horizons and consider alternatives and tactical bets if they want to achieve respectable returns in the coming years, says Research Affiliates’ Rob Arnott.

Transcript

The 3-D Hurricane Hurtling Toward the Economy
A combination of deficits, debt, and demographics will weigh on the U.S. economy for the next 10-15 years, says Research Affiliates’ Rob Arnott.

Transcript

Arnott: Apple Pretty Darn Expensive
Research Affiliates’ Rob Arnott thinks it is unlikely Apple deserves it’s place as the largest market-capitalization company in the country and that investors shouldn’t expect outsized returns.

Transcript

Tags: Apple, Bets, Bonds, Demographics, Economy, Horizons, Hurricane, Investors, Largest Market Capitalization, Mainstream, Morningstar, Research Affiliates, Rob Arnott, Stocks And Bonds, Stocks Bonds
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53% Worry About Not Having Enough Money in Retirement; Implications of Boomer Retirement Plans

Wednesday, April 27th, 2011

by Michael ‘Mish’ Shedlock, Global Economic Trends Analysis

In spite of the massive stock market rally starting March of 2009, worries over retirement are up sharply from 2002. Please consider In U.S., 53% Worry About Having Enough Money in Retirement

A majority of nonretired Americans do not think they will have enough money to live comfortably in retirement, up sharply from about a third who felt this way in 2002. Nonretired Americans now project that they will retire at age 66, up from age 60 in 1995.

Younger Americans Most Positive

Younger Americans are the most optimistic about having enough money to live comfortably when they retire. They are also the least likely to say they will rely on Social Security as a source of income when they retire. This suggests that young Americans are looking optimistically toward other sources of income in retirement.

Nonretired Adults Now Project a Retirement Age of 66

Nonretired Americans now project a higher retirement age than in previous years. When Gallup first asked nonretired adults in 1995 when they expected to retire, 12% said they would retire after age 65. That percentage is now up to 37%. The percentage saying they will retire before age 65 is down from 47% in 1995 to 28% today.

Implications of Boomer Retirement Plans

Note the deflationary aspect of the survey results. Those who fear not having enough money for retirement have a strong incentive to spend less and save more.

Also note the number who expected to retire after age 65 has risen from 12% in 1996 to 37% today. In isolation, this would put upward pressure on the participation-rate and therefore unemployment. However, boomer demographics are such that it will take a decreasing number of jobs to hold unemployment constant.

In 2000 it took about 150,000 jobs a month to hold unemployment steady. Currently Bernanke expects it takes 125,000 jobs a month to hold the unemployment rate steady.

I expect that by 2015 it will only take 90,000 to 100,000 jobs a month to hold the unemployment rate constant.

However, there are millions of individuals who want a job and do not have a job but the BLS does not count as unemployed because they stopped looking for a job. Should those workers start looking for jobs, this too would put upward pressure on the participation rate and unemployment rate.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Demographics, Enough Money, Gallup, Global Economic Trends, Isolation, Market Rally, Massive Stock, Michael Mish, Mish Shedlock, Participation Rate, Previous Years, Retirement Age, Retirement Plans, Social Security, Spite, Stock Market, Survey Results, Unemployment Rate, Upward Pressure, Worries
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Sonders: House of the Rising Sun

Thursday, January 20th, 2011

House of the Rising Sun: A Check-Up on Housing

Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
January 18, 2011

Key points

• Housing is becoming less national and more regional in terms of strength/weakness.
• Affordability is up but so are foreclosures.
• Employment remains key to housing, but be aware of housing’s diminished impact on the economy.

It’s been a while since I wrote specifically on the state of housing and the questions are cropping up again. In particular, I’ve been asked a lot about the relationship between housing and employment, and housing and the economy, both of which I’ll address in this report.

Let me start by summarizing where I think we are in the cycle. Although I believe the overall residential real-estate market is generally finding its bottom, I think we have to take a step back and begin again to look at real estate regionally, not just nationally.

Housing is not a monolith. Yes, when the bubble was inflating the rising tide did lift all (house) boats, and when the tide went out with the bursting of the bubble, it took all (house) boats with it. But I think that’s coming to an end, and going forward we’ll see both pockets of improvement and continued malaise.

Not all housing markets are created equal
Geographic pockets of strength or weakness are typically a function of local economics, inventories and demographics. We’re starting to see more differentiation when diving into the numbers across the country. The S&P/Case-Shiller Home Price Indices were recently released, with data through October 2010. They include a 20-city composite of metropolitan areas, and in terms of the one-year percentage change, here are the top and bottom five regions:

Another way to slice the data is to show the actual index level. For instance, an October index level of 186.7 in Washington DC indicates that average home prices are more than 86% above their January 2000 values. An index level of 68.9 in Detroit indicates that average home prices are still more than 30% below their January 2000 values. That’s the worst showing by far. Below are the rest of the top and bottom five regions based on index level:

Ugly year for foreclosures
The biggest black eye that remains on the face of housing is the foreclosure problem. In 2011 lenders are likely to foreclose on more homes than any other year since the housing crisis began in 2006. The only saving grace is that RealtyTrac believes 2011 will be the peak in foreclosures, predicting 1.2 million homes will be repossessed this year, up from one million in 2010.

The pain will likely be the most acute in states that have already suffered the worst, including Nevada, Arizona, Florida and California, or in states with bleak economic outlooks, including Michigan and Illinois. More than half the country’s foreclosure activity occurred in five states in 2010: California, Florida, Arizona, Illinois and Michigan; meanwhile, Nevada posted the highest foreclosure rate in 2010 for the fourth consecutive year.

Affordability has spiked
But all is not bleak. Most measures of housing affordability have improved markedly. As regular readers know, I keep a close eye on “real mortgage rates.”

Like real gross domestic product (GDP), which is nominal GDP less the inflation rate, the real mortgage rate is the nominal mortgage rate (30-year fixed) minus the rate of inflation (or deflation) in home prices. Remember, it’s not just the mortgage rate that matters to demand, but also the rate at which houses are appreciating or depreciating.

As you can see in the chart below, real mortgage rates have come down substantially from their peak (which corresponded to the trough in the housing market), but remain well above their trough (which corresponded to the peak in the housing market).

Real Mortgage Rates Coming Down

Click to enlarge
Source: FactSet, Federal Reserve, National Association of Realtors, as of November 30, 2010.

The traditional measures of housing affordability have improved meaningfully, too. The first chart below shows the Housing Affordability Index, which is composed of mortgage rates, home prices and personal income data. As you can see, affordability is at an all-time peak. The second chart below shows the ratio of home prices to disposable personal income, and the news is good here, too, as prices have come down to at least a 30-year low.

Housing Affordability Hitting Records

Click to enlarge
Source: FactSet, National Association of Realtors, as of November 30, 2010.

Click to enlarge
Source: FactSet, Federal Finance Housing Board, High Frequency Economics, as of September 30, 2010.

Housing and employment … the connection
The key to improving demand may lie in something else besides affordability, and that’s job growth. The prospects for employment and housing are likely more linked today than any time in history, given the severity of the crisis in both.

As detailed in a study by Ned Davis Research (NDR), real (inflation-adjusted) house prices have historically stopped falling when the unemployment rate has peaked. This potentially bodes well for the housing-is-bottoming story given the drop in the unemployment rate from its October 2010 peak of 10.1% to its present 9.4%. However, real house prices have historically not started to rise until the unemployment rate approaches the “full employment rate (NAIRU).”

Declining Unemployment Rate Should Help House Prices

Click to enlarge
Source: FactSet, Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2011 (c) Ned Davis Research, Inc. All rights reserved.), as of September 30, 2010. Yellow shaded areas represent periods of rising unemployment. Gray shaded areas represent periods from unemployment peaks until 1.2% points above Non-Accelerating Inflation Rate of Unemployment (NAIRU), a level of unemployment below which inflation rises.

The gray shaded areas represent the time from the unemployment rate peak until it falls to within 1.2 percentage points of the full employment rate. (Although it appears as if the unemployment rate peaked last October, until that’s confirmed, the most recent span will remain shaded yellow.)

Assuming the full employment rate is around 7% (NDR’s estimate), real house prices likely won’t start rising until the unemployment rate falls below 8%. If the full employment rate is closer to 6%, as is assumed by many economists, then the recovery could take even longer.

Burst bubbles take longer to heal
As you can see in the chart below, we’re already more than five years into the home-sales downturn, by far the longest stretch (gray bars) in history. The decline in price is rivaled only by the downturn from 1978-1982 when mortgage rates were in double digits and the United States was heading into back-to-back recessions.

Sales Finally Picking Up?

Click to enlarge
Source: FactSet, National Association of Realtors, Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2011 (c) Ned Davis Research, Inc. All rights reserved.), as of November 30, 2010. Gray shaded areas represent downturns.

This downturn is the result of a bubble that burst, but was certainly exacerbated by the related financial crisis and severe recession. NDR compared this bubble to a composite of the four historic mega-bubbles: the Dow Jones Industrial Average in 1929, crude oil in 1980, the Nikkei in 1990 and the NASDAQ in 2000, seen below.

Housing Following the Bubble Path

Click to enlarge
Source: FactSet, Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2011 (c) Ned Davis Research, Inc. All rights reserved.), Standard and Poor’s. Historical Bubble Composite as of January 1, 2002, thru May 31, 2016. Case-Shiller Composite as of October 31, 2010.

The picture of the prior bubbles is consistent with our view that housing has probably broadly bottomed, but the path up is likely to be relatively flat, elongated and volatile among geographic regions.

Housing and GDP … the connection
Finally, the real key question is the impact of housing on the overall economy. One of the most common questions I get is whether we can get decent GDP growth without housing doing the heavy lifting, as it did in the last up cycle. Here’s where I think many people have it wrong, much as they did after the bursting of the tech bubble in 2000.

As the economy exited recession in 2001, the thinking was that the economy couldn’t recover without leadership by technology, given its prior power as an economic driver. However, from the peak in 2000 when equipment and software represented more than 9% of GDP, it was subsequently on its way to near 6% by 2008 … only since then has it begun to rise again. The economy recovered, as did the stock market, without leadership from technology.

As you can see in the final chart below, housing has been on a similar path. At the peak, residential real estate represented more than 6% of GDP, whereas now it’s a record low of little more than 2%.

Housing Is Less Important to GDP

Click to enlarge
Source: Bureau of Economic Analysis, FactSet, as of September 30, 2010.

That of course doesn’t mean housing can’t be a negative contributor—it just means there are other forces that have gained power as this cycle has unfolded. As an example, auto production now accounts for a larger share of GDP than housing, and its prospects are looking much better.

Upside potential?
The potential good news is that housing starts have been running at a pace of only 40% of their 30-year average, well below the household formation rate. In addition, we’re seeing improved price and volume performance for non-distressed sales. Supply is heading back up thanks to increasing foreclosures, but we could be getting close to the last ugly Case-Shiller report and the market-clearing process should pick up in the spring selling season.

Necessary ingredients for a healthy recovery in housing would be the aforementioned down slope in the unemployment rate, a further loosening of the credit environment, no significant (further) spike in mortgage rates, and general improvement to consumer confidence. Again, we believe the prospects for housing are improving, though certainly not stellar, but our optimism about the economic recovery could feed into better-than-expected housing news as well.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative (or “informational”) purposes only and not intended to be reflective of results you can expect to achieve.

Copyright (c) Charles Schwab & Co., Inc.

Tags: Affordability, Charles Schwab, Chief Investment Strategist, Demographics, Differentiation, Foreclosures, House Of The Rising Sun, Index Level, Inventories, Liz Ann, Malaise, Metropolitan Areas, Monolith, Percentage Change, Pockets, Price Indices, Residential Real Estate, Rising Tide, Senior Vice President, Top And Bottom
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Rob Arnott: Deficits, Debt, and Demographics Will Impede Real Returns For Next 25 Years

Thursday, November 26th, 2009

In his latest newsletter (November 2009), The “3-D” Hurricane Force Headwind, Robert Arnott (founder, Research Affiliates) examines how Deficit, National Debt, and Demographics, the 3 Ds, mean that we should lower our expectations for real return from markets over the next 25 years. Arnott, a fundamental indexing academic and innovator, has been warning, via his papers, that investors be modest. For example, it is interesting, given that Research Affiliates, the creators of fundamental equity indices, that its founder, Arnott, has spent most of the last year discussing bonds, and reversion to mean.

Here are a few excerpts from the latest newsletter.

In this issue we examine three critical long-horizon issues — the deficit, the national debt, and demographics—and find a disturbing structural headwind that will impede the real returns we can expect from financial assets in the years ahead. The coming quarter century will be very, very different from the past quarter century; the lessons we’ve learned in the past generation may lead us astray in the coming  generation.

On the (D)eficit:

The latest year shows a deficit of 10% of GDP, but even this isn’t a problem as long as it’s a oneoff deficit incurred to help avert a major financial and economic crisis. Right? Right… if the past average really was 2.4% and the current deficit really is temporary.

But …

The average increase in our national debt, including unfunded obligations and GSEs, soars to 9.8% of GDP for the past 25 years. The latest 12 months saw our public debt and unfunded obligations grow by 18% of GDP! No wonder the debt seems to have grown crushingly large.

Arnott’s case is compelling, and sounds quite similar to what his Newport Beach bond market peer, Bill Gross, calls the “New Normal,” though Gross has not elaborated on it as specifically, as Arnott does here and in past letters. Whether you agree with this or not, its a must-read.

For more on Debt and Demographics, and to read Rob Arnott’s complete newsletter, click here.

Tags: Bill Gross, Bond Market, Coming Generation, Demographics, Economic Crisis, Financial Assets, Fundamental Indexing, GDP, Headwind, Horizon Issues, Hurricane Force, Innovator, National Debt, Newport Beach, Public Debt, Quarter Century, Research Affiliates, Reversion, Rob Arnott, Robert Arnott, Soars
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