David Rosenberg: It’s Time to Implement Defensive Strategies

To protect your portfolio in this deflationary landscape, a pervasive focus on capital preservation and income orientation, whether that be in bonds, hybrids, or a focus on consistent dividend growth and dividend yield would seem to be in order. Words: 1380

In further edited excerpts from the original article* David Rosenberg (www.GluskinSheff.com) goes on to say:

CONSENSUS OPINION FOR 2010
After perusing several Wall Street research documents on what to expect for 2010 I found, however, that the overwhelming consensus view was as follows:

• Muted recovery but still GROWTH

• Equity markets will be UP

• Most popular forecast involves a large-cap multi-national/emerging market barbell for equity allocation

• Decided preference for emerging markets as that is where the growth is going to come from

• This adds up to expectation of 4% to 5% for global GDP growth; 2% to 3% for the U.S.A.

• Generally neutral on the U.S. dollar

• Positive on commodities

• Negative on long government bonds across the board because of concern over government balance sheets

• Overall constructive view on credit product, especially for shorter-term maturities

MY THOUGHTS ON THE OUTLOOK

The credit collapse and the accompanying deflation and overcapacity are going to drive the economy and financial markets in 2010.

This recession is really a depression because the recessions of the post-WWII experience were merely small backward steps in an inventory cycle but in the context of expanding credit whereas now we are in a prolonged period of credit contraction, especially as it relates to households and small businesses.

In addition, we have characterized the rally in the economy and global equity markets appropriately as a bear market rally from the March 2009 lows, influenced by the heavy hand of government intervention and stimulus.

2010 may well be seen as the year in which we witness the inevitable drawn out decline that is typical of secular bear markets.

The defining characteristic of this asset deflation and credit contraction has been the implosion of the largest balance sheet in the world — the U.S. household sector. Household net worth has contracted nearly 20% over the past year-and-a-half, a degree of trauma we have never seen before.

Frugality is the new fashion and will likely stay that way for years as attitudes toward discretionary spending, home ownership and credit undergo a secular shift. As households begin to assess the shock and what it means for their retirement needs, the impact of this shocking loss of wealth on consumer spending patterns in the future is likely going to be very significant.

What has really impressed me is what the general public has been doing with their savings, which is to allocate more towards fixed-income strategies. Looking at the U.S. household balance sheet, what I see on the asset side is a 25% weighting towards equities, a 30% weighting towards real estate and there is obviously a lot in cash and deposits, life insurance reserves and consumer durables, but the weighting in fixed-income securities is less than 7%. So my contention is that this is the part of the asset mix that will expand the most in the next five to 10 years.

What also makes this cycle entirely different from all the other ones experienced in the post-WWII era is that this is the first consumer recession we have witnessed where the median age of the baby boom population is 52 going on 53. The last time we had a consumer recession in the early 1990s, the boomer population was in their early 30s and they were still expanding their balance sheets. The last time we had a bubble burst in 2001 they were in their early 40s. Now they are in their early 50s, the first of the boomers are in their early 60s, and we are talking about a critical mass of 78 million people who have driven everything in the economy and capital markets over the last five decades. This cohort realize that they may never fully recoup their lost net worth, and yet they will probably live another 20 or 30 years.

So, what is happening, which is at the same time fascinating and disturbing, is that the only part of the population actually seeing any job growth in this recession are people over the age of 55. Everyone else can’t get a job or are losing jobs — there is a youth unemployment crisis in the United States of epic proportions and a record number of Americans have been out of work for longer than six months in part because the “aging but not aged” crowd is not retiring as early as they used to.

Many retirees who took themselves out of the workforce because they believed that their net worth would provide for them sufficiently in their golden years are redoing their calculations and coming back to the workforce to make up for their lost wealth. They are seeking income in the labour market, not because they want to but because they have to in order to satisfy their retirement lifestyles.

We can understand that there are concerns over inflation, but the history of post-bubble credit collapses is that even with massive policy reflation, deflation pressures can dominate for years — this was certainly the case in the U.S.A. and Canada in the 1930s, and again in Japan from the 1990s until today. Income strategies in both cases worked well with minimal volatility.

Of course, all the talk right now is about reflation and all the efforts from the central banks to create inflation, but the facts on the ground show that the inflation rate for both consumers and producers has turned negative for the first time in six decades. Perhaps inflation is a consensus forecast but deflation is the present day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years.

So, to protect the portfolio in this deflationary landscape, a pervasive focus on capital preservation and income orientation, whether that be in bonds, hybrids, or a focus on consistent dividend growth and dividend yield would seem to be in order.

What has become crystal clear is that the U.S. government has taken over the beleaguered U.S. dollar, which can only be described as benign neglect.

2010 is a mid-term election year in the U.S. and the Administration will do everything it can to squeeze every last possible basis point out of GDP growth and to prevent the unemployment rate, the most emotionally-charged statistic of them all, from reaching new highs.

While I still believe that a sustainable return to inflation is a long ways away, there is little doubt that we will see continuous efforts at policy reflation, which means that the U.S. money supply is going to continue to expand rapidly, which in turn is positive for commodities, which are after all priced in U.S. dollars.

On top of all that, it does appear from a volume demand perspective, that the secular growth dynamics in Asia, China and India in particular, have reasserted themselves and this part of the world is the marginal buyer of commodities. This is the key reason why the Canadian stock market, given its resource exposure, has continued to do very well in comparison to the United States, especially when the positive trend in the Canadian dollar enters the equation, and I expect this outperformance to continue.

One conclusion I think we can agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive such as in fixed-income and in equity sectors that lever off the commodity sector, under the proviso that the “experts” are correct on this particular forecast — that China and India remain the global growth leaders.

*http://www.godlikeproductions.com/forum1/message940992/pg1

Editor’s Note:
- The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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