With all the talk of a recession, Gluskin Sheff Chief Economist and Strategist David Rosenberg doesn’t think we’re anywhere close to one, although he notes that investors are widely hedging against a possible recession. From looking at the high-yield corporate bond market and the stock markets, he believes the markets are pricing in a one-in-three chance, which he calls “improbable.”
Rosenberg pegs the S&P 500’s fair value at approximately 1,850, and he noted that we’ve already plunged below that.
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He also says though that there’s no reason the equity risk premium can’t increase soon adding, “All that said, if you have a long enough time horizon, recognize value when it opens up.”
Rosenberg takes us back in time to 1950, and investors who grabbed up the S&P in the same month it plunged 20% year over year, the average return the next year was 8.2%. The three-year return jumped to 19.7%, while the five-year return was 32.3%. Looking at the Canadian TSX, the increases were 14.4%, 29.1% and 56.5%, respectively.
Why investors are spooked
He also gave 10 reasons he thinks investors have been spooked this week in his “Breakfast with Dave” note. For example, he said investors are no longer confident in whether the monetary policies of the world’s central banks are working. Second, he noted that oil prices are still volatile and especially weak, and thus far, it doesn’t look like Saudi Arabia or the U.S. will be adjusting supply.
He also highlighted the 3) rising risks of corporate defaults and 4) noted that most of the money consumers are saving on gas and energy is being saved rather than spent. Further, 5) the devaluation of the yuan and the risks associated with a hard landing in China have been causing concern since August. Rosenberg also noted that 6) the growth of the U.S. gross domestic product has stalled, and not only that, but this is coupled with an earnings recession, contraction in manufacturing, and reductions in capital expenditures.
7) Trouble among European banks ups the ante further as the macroeconomic issues are not limited to just one or two global regions, and 8) the fiscal issues in Greece have reared their ugly heads again, with Portugal not looking any better either. We’re also seeing 9) signs that even more countries will move to negative interest rates, and 10) the outcome of the U.S. presidential race is uncertain with Bernie Sanders gaining ground against fellow Democrat Hillary Clinton as the U.S. primaries get underway.
Recession worries overdone
Rosenberg sees the actual risk of a recession occurring as only slightly higher than 5%, making him far more optimistic than most of the rest of the markets. We highlighted his views on why he doesn’t think a recession is just around the corner on Wednesday, but here’s his bottom line, which he explains is not his view “as much as what the markets are telling us and pricing in at the current time”:
“Suffice it to say while the situation appears dire, we are finding needles in the haystacks and some appealing value is surfacing in areas of the market like the North American Financials, High-Yield bonds, and parts of the Consumer Discretionary space which will undoubtedly benefit from the nascent uptrend in U.S. wage growth and the eventual response to a reversal of the personal savings rate which was largely related to the oil price decline.”
He went on to say that the macroeconomic turmoil we’re seeing now isn’t the fault of oil, China, the U.S. dollar or geopolitics because these issues are mostly in the past. Rosenberg then mapped the progress of the global worries over the last year: the Swiss National Bank–> Greece –> the Fed–> the U.S. dollar –> (currently) European banking fears with global contagion risks; central bank monetary policies; and “the sharp tightening in financial conditions risking a feedback-loop recession that would exert knock-on effects right back on the capital markets.”