David Rosenberg: What Is Really Bugging The Market

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Outside the Box: What Is Really Bugging the Market by John Mauldin

My good friend David Rosenberg, Chief Economist at Gluskin Sheff, has long been one of the biggest draws at my annual Strategic Investment Conference. I had always taken him for a “permabear.” Then three years ago, Dave shocked us by announcing in no uncertain terms – in his usual fire-hose delivery of hard data and brilliant analysis – that he had turned decidedly bullish. His call was of course spot on.

Dave will once again kick things off at this year’s SIC, and you’ll want to be there to catch his every valuable, investable word. David is only one of our all-superstar cast. At SIC we have only headliners, people who would keynote any other investment conference. You get to see them all in one place.

I can say with some justification (and a measure of pride) that SIC is the best economic gathering on the planet, and SIC 2016 is going to be our best yet. The dates are May 24-27, 2016, and this year we’ve moved the conference to Dallas, my home turf, with easy access from anywhere in the world. Just as you’ve come to expect, we’re tackling a big theme: “Decade of Disruption: Investing in a Transformed World.”

In the decade ahead, you and I will not be able to successfully invest in the same way we did in past decades. Our world is transforming at an ever-accelerating rate, and we’re going to need a more comprehensive understanding and better tools if we’re going to invest in that world profitably.

To see how SIC16 will help you with those aims and to get all the particulars on registration, click here. And don’t tarry: if you register by January 31 you’ll save $500 off the walkup rate.

And now let’s get back to Dave. To give you a taste of where he’s going these days, I’ve asked him to let me excerpt a key section from this morning’s edition of Breakfast with Dave. He asks, “What is really bugging the market?” And then he tells us, with the clarity and conviction that only a very few people in our business can muster.

OK, time to sign off and hit the sack! I just landed in Hong Kong and I already feel the jet lag oozing through my pores. I’ll be back this weekend, though, with my annual forecast issue, and I promise it will make for lively reading. I had hoped to finish it on the flight over, but I just had to finish catching up on 2015 and clear the decks for the big year ahead of us.

Your thinking that disruption means opportunity analyst,

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Each week, John Mauldin highlights a thoughtful, provocativeessay from a fellow analyst or economic expert. Some will inspire you. Some will make you uncomfortable. All will challenge you to think outside the box.

What Is Really Bugging the Market

By David Rosenberg, Gluskin Sheff + Associates Inc.

Excerpted from Breakfast with Dave, January 6, 2016

The overriding problem for the equity market remains one of valuation – not that we are in bubble territory, but more that the stock market is still quite expensive.

The price action of 2015 failed to resolve one thing, which was to correct the excess valuations that held back the market last year as it likely will this year too.

The trailing price-to-diluted earnings multiple is 21.4x versus the historical norm of 17.5x, while the forward multiple on the S&P 500 is 16.8x, and again, the mean has been closer to 14.4x. The Shiller cyclically-adjusted price-to-earnings (CAPE) ratio is 26 and the long-run average is 23. Capish?

So here we have the stock market, according to many measures, trading close to three multiple points above historical norms.

Like the personal savings rate in the macro world, the price-earnings multiple in the financial world is a behavioral aggregate – a signpost of confidence, if you will. A lower savings rate is symbolic of higher confidence over income or wealth prospects, and similarly a higher multiple is a characteristic of rising investor confidence over the outlook for market returns.

The problem is that we do not have the clarity, certainty or visibility across the globe, whether it comes to policy, oil prices, regional conflicts or China, to warrant multiples being this far above the norm, if at all.

So, 2016 is likely going to be a year of transition and one where uncertainty is going to dominate the macro and investing landscape.

Oil prices

The fact that oil prices could not catch much of a bid given the conflict between Iran and Saudi Arabia should have the bulls shaking their heads.

The reality is that supply is an impediment at a time when there has still not been a dent in U.S. production and OPEC has been pumping out 32 million barrels per day (far above its quota) for seven months in a row.


The severing of diplomatic ties between Iraq and Saudi Arabia could be problematic for investors risk tolerance if the situation turns worse, as in some form of military response. At a minimum, it complicates efforts to resolve the internal crisis in Syria.

It also further exposes the failure of U.S. foreign policy under the current administration (underscored by the surge in Aerospace & Defense sector stocks last year).

The Fed

Several monetary policy makers, including San Francisco Fed President John Williams (who is reportedly close to Janet Yellen), struck a hawkish tone at the regional bank’s symposium.

Also, Cleveland’s Fed President Loretta Mester sounds very hawkish and has openly argued that the Fed should turn a blind eye to the stock market (the rotated voting membership this year has a slightly more hawkish tilt than it did in 2015).

Finally, there was nothing out of Fed vice chair Stanley Fischer to suggest that the Fed is going to stop at one or two hikes.

The Fed has never hiked rates with the ISM manufacturing moving below 50, let alone for two straight months now. This a transition, first away from quantitative easing, and now away from zero interest rate policy, but with a twist since the central bank has never tightened policy with manufacturing under so much duress.


The consensus is looking for around 8% S&P 500 earnings growth this year and yet the analysts have dragged the earnings revision ratio down to the lowest levels in eight months (to 0.55x for the three-month ratio in December from 0.58x in November and 0.74x in October; declining now for four months running).

Another transition will be what rising wage growth will do to profit margins – a case of what is good for Main Street may not be so good for Wall Street (call it mean reversion from the past six years of 18% equity returns and a mere 2% growth trend in the broad economy).

Local politics

Another transition this year is the U.S. election this November and if Byron Wien is prescient on his “surprise” pick for the Republican nominee being Ted Cruz, and the Democrats take over control of the Senate – well, it will likely be tough to build a positive market view from such heightened uncertainty.

As well, Donald Trump is not going out with a whimper either – there may be blue-collar voters who would be happy if he became President but I’m not sure the stock market would take it well (ditto for Ted Cruz with a Democratic-controlled Senate ushering in more years of gridlock).


While I am personally not bearish on the economy, it remains a “show me” situation and many pundits are becoming concerned over possible capital flight from any additional yuan devaluation.

Also, signs that the rebalancing from fixed investment and industrialization towards the consumer and services may not be going as smoothly as earlier believed are unnerving investors too.


There is uncertainty over how the influx of migrants will affect Germany; how the U.K. will vote on the European Union referendum; signs of foot dragging from Greece on pension reforms; and secessionist pressures surfacing in Spain.

The European Central Bank is at or near the bottom of the barrel when it comes to monetary easing at this point – the laws of diminishing returns may be setting in.

That said, some of the recent data flow has been encouraging.


Uncertainty in Japan regarding the efficacy of Abenomics and whether the Bank of Japan has done enough, notwithstanding how aggressive it has been, to fully thwart the ongoing deflation threat. But at least the latest recession last year managed to get revised away.

U.S. growth

While autos, housing and consumer spending are doing fine, exports, commercial construction, transports and manufacturing clearly are not.

That the Atlanta Fed’s GDP “nowcast” is tracking growth for Q4 at a 0.7% annual rate, down from 1.3% just a week ago and 2.0% back in mid-December – that is a sharp downdraft in a short time frame.

Manufacturing may only be 10% of GDP, but it does touch a lot of other ancillary sectors and only six of 18 industries polled by the Institute for Supply Management posted any growth at all in December.


This comes back to the Fed and maybe the bond market, but if there is complacency out there, whether in the bull or bear camp, it is that inflation is dead. It is not. It may be comatose, but not dead.

I sense that 2016 will bring with it more price gains in rents, big accelerations in health services, health care premiums, and wages. Core service sector inflation is already approaching 3% – imagine if the dollar stopped going up and commodities stop going down, as such preventing goods sector deflation from acting as an antidote?

Bottom line

As I said on CNBC yesterday (yes, Joe, I am also a strategist), I am not looking for a down year for the S&P 500 but am cautious over the near-term (flat is the new up).

Since I do not see a recession, and you only get successive down years in a recession, I doubt therefore that we will suffer the ignominy of another retreat in the S&P 500.

That said, after seeing returns more than triple this cycle and price-to-earnings multiples above historical norms, it goes without saying that we have borrowed returns from the future in a very major way.

As was the case in 2015, if you are buying the market, be happy with the reinvested dividend comprising much if not all of your total return.

Again, like 2015, the key to doing better than that will involve agility, opportunism, more discipline than normal (as in raising and deploying cash at the appropriate times), and having concentrated positions in the right sectors (such as being long the U.S. consumer last year which would have garnered an 8%+ return).

In general, anticipate an environment where active will beat passive investment management. We had a taste of this in 2015; expect much more of the same this year.

As for the economy, I think we will be just fine, and there will be more of the “neither boom nor bust” cycle.

Consumer spending in real terms is up 3.2% on a YoY basis. New home sales are up 9%. Housing starts by 16%. And both auto sales and production are up 6%. So while still soft overall, keeping in mind how tight monetary policy is given the dollar strength, the restraint in financial conditions from the surge in high-yield credit spreads, and a still restrictive fiscal stance, the economy is doing all right.

The key will be when net exports finally stabilize and at what point the business sector will feel more comfortable over the outlook to start expanding. Not until these two areas start to gain momentum can we talk about the U.S. economy, in aggregate, reaching or exceeding a 3% annual pace.

Now that would probably justify multiples closer to where we are today, but is a trend that has remained elusive for a long, long time – we have not seen a “three-handle” on real GDP growth since 2005. Is that you, Godot?

I mentioned the High-Yield corporate bond market so I will finish off there. This is where the best risk-reward opportunities may well reside for the coming year.

For more information or to subscribe to Gluskin Shef economic reports, visit www.gluskinsheff.com.

You can hear Dave’s latest thoughts in person at this year’s Strategic Investment Conference. Register here while there is still an early-registrant discount.

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