The following is a summary of our recent FS Insider podcast, “Rosenberg: Take Profits and Hedge – We Are Very Late-Cycle,” which can be accessed on our site here or on iTunes here.
The US stock market is booming! Nearly every index is hitting all-time record highs as investors price in a major tax cut to corporations before Christmas. What could go wrong?
David Rosenberg, the well-known chief economist and strategist at Gluskin Sheff, says fiscal policy stimulus via a tax cut is coming at a bad time and will likely lead the Fed to raise interest rates faster than normal, which could be a problem for a US stock market that is already ‘very expensive.’
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Here’s what he told listeners last week:
Bad Timing for Tax Stimulus
“Look at what the Fed is doing. The Fed is raising interest rates now principally so that they will have conventional policy bullets to fight the next recession. Janet Yellen told us that at Jackson Hole back in August of 2016 so the question would be why would you stimulate fiscal policy heading into the ninth year of a late-cycle expansion? Why wouldn’t you save your policy bullets from a fiscal perspective to also fight the next recession? This is going to put the Fed in a bit of a box because…this is (economic) stimulus with a 4% unemployment rate heading into the ninth year of an expansion, which is going to cause the Fed to raise rates more than they otherwise would have. So I think the timing is really bad…”
Fiscal Policy Losing Effectiveness
“I’m all for lower corporate tax rates…there’s no doubt that the corporate tax structure has to be changed, but not at the expense of raising the deficit at a time when the deficit is already 3.5% of GDP and a time when the gross public debt is more than 100% of GDP.”
“The impact of fiscal policy on the economy is not linear. If we had a balanced budget and we had a national debt to GDP ratio that was closer to 60% than 100%, you get a much bigger bang for the buck. But the higher the debt ratio is, the less the multiplier impact is on any sort of government stimulus, whether it’s on the spending side or the taxation side…”
Monetary Policy Much More Important
“We are only three hikes away from the Fed inverting the yield curve and already I’m seeing economists publish research yet again trying to dismiss the yield curve like we saw in the last two cycles as well. I think this complicates efforts for the Fed. I hearken back to the first tax cut engineered by Ronald Reagan in 1981 when he took the top marginal personal rate from 70% down to 50%; and remember how Paul Volker responded to that by raising rates and, quite unexpectedly and as a surprise to most economists at the time, we had a six quarter recession on our hands despite the fact that we had fiscal stimulus, which tells you that monetary policy is a much more powerful force on the economy and the contours of the market cycle than fiscal policy is.”
US Stock Market ‘Very Expensive’
“I think that the market is very expensive. I don’t know if I would classify it necessarily as a bubble but…even with the tax stimulus, if you want to add on the $10 earnings per share with a lot of the goodies you’ll get with the Senate and House version, you’re still left with a 17.5 forward multiple for 2018. Historically, the forward multiple is 15 and 17.5 is really what the peak was back in 2007, so you don’t have to get hysterical and talk about comparing it to 1987 or comparing it to the dot-com bubble but, as I said earlier, you don’t have any fear priced into anything. Even with the earnings boost, even with a 15% growth expectation for operating earnings next year, you are still left with a 17.5 multiple so I’m not saying it’s a bubble but I am saying that the market is expensive. I understand—I’ve been doing this for 30 years—you don’t look at valuations as market timing devices but certainly if you don’t have a sense of market valuations, it’s tough to actually tell anybody what your expected returns are going to be in the future. And I think the multiples tell you that those expected returns are seriously constrained at this moment.”
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