Freedom

Opinion by Jonathan Burton

It’s said that you don’t know an economy is in a recession until it’s in one. Or as David Rosenberg puts it: “Recessions are like an odorless gas. They sneak up on you.”

These days, Rosenberg is looking for fresh air. A former chief North American economist at Merrill Lynch and now president of Toronto-based Rosenberg Research, Rosenberg sees the U.S. Federal Reserve ending its rate hikes soon — but says the economic damage has been done. He expects U.S. businesses and consumers to cut spending, unemployment to rise, and companies and consumers to turn increasingly cautious as the U.S. economy slips into recession.

And, for anyone who is convinced that the Fed will pull off an economic “soft landing,” Rosenberg has two words: Dream on.

“There is no chance we’re having a soft landing in the context of the most pernicious tightening by the Fed since the Paul Volcker years,” Rosenberg says.

In a recent interview with MarketWatch, which has been edited for clarity, Rosenberg gives the Fed no credit — and no mercy. He elaborates on the sobering investment and economic themes and topics he discussed in a late April MarketWatch interview, and says recession is unavoidable.

With that in mind, Rosenberg steers investors into defensive, rate-sensitive areas of the stock market, including utilities, consumer staples and REITs. In the bond market, he advocates a “barbell” approach that positions a portfolio in both short- and long-term securities.

MarketWatch: U.S. Treasury Secretary Janet Yellen says she doesn’t expect a recession. J.P. Morgan Chase CEO Jamie Dimon says U.S. consumers are in good shape. What does your crystal ball say?

Rosenberg: Janet Yellen is a politician. Why would she ever be calling for a recession? So we want to fade her views on the macro scene. She has a clear bias. And if I were in her shoes I would be saying the exact same thing.

It’s interesting to hear Jamie Dimon talk about how great a shape the U.S. consumer is in when we are seeing delinquency rates rise across virtually [the entire] gamut of the household borrowing space. It’s equally interesting to hear Dimon talk about how great things are when the pace of bank lending, in the aggregate, is heading towards negative territory on a year-to-year growth basis for the first time since we pulled out of the Great Financial Crisis. These bank CEOs may not be politicians, but they are quasipoliticians.

So to talk to me about what politicians are saying is a waste of time. To hear what bankers are saying on television, because they are quasipoliticians, is almost an equal waste of time. Look at the data. While we did escape the worst possible situation, which would have been systemic financial risk coming out of the banking crisis last winter, saved yet again by the Fed’s omnipresent, ubiquitous balance sheet, we are still heading into a period of significant tightening in bank lending guidelines. You’re seeing that because, even as deposits have started to stabilize over the past two months, bank credit has been contracting.

The banks are rapidly building liquidity, which is telling you that behind closed doors they are more concerned than they’re letting on.

What have the banks been adding to their balance sheet? Cash assets. So as the bankers show a “What, me worry?” face on television, what they’re doing is shifting their balance sheet from nonliquid assets, which are basically private-sector loans, towards cash. The banks are rapidly building liquidity, which is telling you that behind closed doors they are more concerned than they’re letting on.

MarketWatch: You’ve been predicting a sharp U.S. economic downturn for a long time now, and yet the stock market keeps going up. How do you explain this, and what keeps you confident about your base case?

Rosenberg: Are you really asking me to fit my narrative into what the stock market is doing? The S&P 500 peaked in September 2000; the recession that nobody saw coming started in March 2001. The stock market peaked in October 2007; the recession that nobody saw coming began in December, two months later.

In October of 2007 I was chief economist at Merrill Lynch. On Oct. 9 of that year, which was when the U.S. stock market hit its peak, I gave a presentation to the Federal Reserve in Washington. I was calling for a recession. The head honcho at the Fed who hosted me said, “Mr. Rosenberg, are you aware that the S&P 500 hit a new all-time high today, and here you’re talking about a recession.”

Can you imagine what would have happened if I changed my forecast because of what the S&P 500 did in October 2007? Should I have based my forecast on where I thought the stock market was going to be in October 2008? So the fact that we now have a speculative frenzy, animal spirits coming back and driving up the multiple in the stock market is just a stock-market story. It’s not telling you an economic story.

If there was truly a wave of inflationary growth coming, the 10-year Treasury yield would be closer to 5% than 3.8%. We would be having a boom in commodity prices. If we were in some sort of domestic-demand-induced economic boom, why would the U.S. dollar be moving into a bear market?

Think of the ridiculous situation we’re in. The Fed is pegging the funds rate in a 5.25% to 5.5% range. The 10-year Treasury yields 3.8%. What is the bond market telling you? The bond market is not telling you the same goldilocks story the stock market is telling you. When we look at the action in most raw industrial prices, including oil over the past year, it isn’t a very positive economic synopsis. Then you have to ask, what is going on with the U.S. dollar if things in America are so hunky-dory?

So I would say that the stock market seems to be the odd man out.

We’ve had the soft landing. You always have the soft landing as you’re making a transition from the business expansion to the economic recession.

MarketWatch: Many market experts and investors expect a ‘soft landing’ for the U.S. economy — and give the Fed credit. What’s your view?

Rosenberg: We’ve had the soft landing. People are extrapolating what’s happening today with what’s going to happen over the next few quarters. That’s very dangerous, if not irresponsible.

You always have the soft landing as you’re making a transition from the business expansion to the economic recession. People think that somehow this is a resting spot. It is not. Not when the Fed raises rates into an inverted yield curve, which it began doing a year ago.

I wasn’t talking about a recession happening in 2022. Everybody knows there’s a lag of between six [and] 18 months. The recession may not start until next year. It could start this coming quarter. There’s evidence that recession may have already started, if you look at real GDI [gross domestic income] instead of real GDP, and look at the index of aggregate hours worked instead of just nonfarm payroll.

People are trying to fit the macro narrative into what’s been happening in the stock market. The stock market doesn’t always tell you what’s happening with the economy. It might be telling you about sentiment and market positioning and technicals, but it’s the same stock market that was telling you in October 2007 that we were going to have unbridled growth. The recession started two months later.

Right now the stock market has become a get-rich-quick scheme like it was during the meme-stock mania two years ago. The stock market today is not a vehicle to raise capital. Companies buy back stock to make their shareholders wealthy. The stock market is operating on momentum and fund flows and sentiment and technicals. Investors now are bowing down to the holy grail of price momentum.

To suggest to me that the stock market is telling us something about the economy is just laughable. Is anybody that foolish or ignorant of history to suggest that we’re in a resting spot — that we’ll still be talking about a soft landing this time next year?

The question is will we stay in the soft landing? Of course not. This is the most credit-driven economy in history. It’s been completely reliant on low interest rates for so long, sucking at the teat of the central-bank balance sheet. The Fed started a tightening policy in March 2022. There’s a lag. People who are saying this is a soft landing and so there’s no recession — those will be the people wiping egg off their face.

MarketWatch: Given your position on recession, are you surprised that the U.S. labor market is still so strong?

Rosenberg: Not a bit. The unemployment rate is the laggiest of the lagging indicators. It’s not unusual for the unemployment rate to be going down as the recession starts. The only thing that’s really different this time is that companies are hoarding labor, which is why employment has been so slow to contract, and what they’ve been doing instead is cutting hours.

Everybody trades off of nonfarm payrolls without realizing that the workweek is at the same level it was at in April 2020 when most of the economy was in lockdown mode. So when you look at the labor market as not just unemployment but also the number of hours people are putting in on the job, the index that combines bodies and hours peaked in January 2023. People talk about a strong labor market only because they’re focused on nonfarm payrolls.

Companies are hoarding labor. But why are they cutting hours? Because business activity is starting to slow.

Companies have been loath to lay off people out of fear that in the next cycle they won’t be able to find them again. That was one of the scars from COVID and the lockdown, and the ridiculous way the government dealt with the situation, which was to pay people more money to be unemployed and then extending those jobless benefits well into the recovery.

So companies are hoarding labor. But why are they cutting hours? Because business activity is starting to slow. When you go to the Conference Board indicators, the unemployment rate is in the index of lagging indicators. Nonfarm payrolls is in the index of coincident indicators. But the workweek is only one of two labor-market components in the index of leading indicators, alongside initial jobless claims, which are also starting to wave a yellow flag.

Focus on the leading indicators. For those who don’t want to look through the rear-view mirror, as many including the Fed are, leading indicators of employment, like hours worked, tell you that employment is going to be weakening in the next six to 12 months.

MarketWatch: If I’m working fewer hours, then of course I’m going to be more budget-conscious. How do you see consumer spending — the economy’s engine — holding up?

Rosenberg: Unless you believe this cycle has been repealed, the unemployment rate will be going up. Wage rates will be adjusted lower. The decline in inflation will help buffer this, but the kicker is going to be that the excess-savings story which was the Energizer bunny that kept the consumer going for as long as it did has pretty well run out. The reason we had an economic boom in the context of the pandemic was we had a virtually unprecedented cash transfer from Uncle Sam to everybody.

I’ve been doing this 40 years. What I’ve seen too many times are people who can’t see past the tip of their nose. They extrapolate their most recent experience into the future, which I’m recommending people don’t do. Do not follow the pied piper. Do not follow the soft-landing advocates. There is no chance we’re having a soft landing in the context of the most pernicious tightening by the Fed since the Paul Volcker years.

We are past peak growth, past peak inflation, and about to go past peak interest rates.

If you want to bet against history, bet against history. But data back to 1948 tell me that the only times we had a soft landing in the context of rising interest rates was when the Fed stopped tightening before the yield curve inverted. Like Alan Greenspan did in the mid-1990s and Paul Volcker did in the mid-1980s.

But we now have a central bank chief who has compared himself to Paul Volcker. If you tell me we will have a Paul Volcker–like monetary tightening cycle without a Paul Volcker–like economic cycle, that’s the most ludicrous thing I’ve ever heard.

Consider this: Recessions are like an odorless gas. They sneak up on you. You don’t even know you’re in one when it’s already started. The economy is not bitcoin or the S&P 500 — it doesn’t bounce around; it’s fairly stable. So when the economy morphs from expansion to soft landing to recession, it doesn’t happen overnight; it’s six to 18 months.

MarketWatch: It sounds like investors ought to focus on the bond market and in the stock market, on less cyclical, more need-to-have types of products and services.

Rosenberg: You want to be in consumer staples, healthcare, and rate-sensitive stocks. We are past peak growth, past peak inflation, and about to go past peak interest rates. I would include real-estate investment trusts [REITs] and utilities. Be defensive and rate-sensitive. I want the earnings visibility you get in most parts of healthcare and consumer staples. I want that rate sensitivity you get from selected REITs and utilities.

This has been a speculative, momentum rally, not a fundamentally based rally. So count your lucky stars and take profits in equities and start deploying to the Treasury market. Interest rates are going to come down more quickly at the shorter end of the curve. The yield curve has to mean revert. We are in a bizarre situation with a yield curve that’s been inverted for the past year. The curve will normalize. You’re getting paid nicely in Treasury bills; barbell between short-dated securities and the long bond.

MarketWatch: What signals will the Fed telegraph after its meeting this week and, not incidentally, with Powell’s speech at Jackson Hole coming up in August?

Rosenberg: The interesting thing about the Fed is that, at its last meeting, they paused and said we’re going to be data-dependent but we’re also going to hike rates at the next meeting in July. They want the markets to be positioned for this — they raised rates and they’re not done.

Powell may use the Jackson Hole symposium to signal to the market that the rate cycle has either peaked or is in the process of peaking.

The one thing that leads me to believe they could be done at this week’s meeting is the Jackson Hole Economic Symposium in August. The beauty about Jackson Hole is that Powell can speak for himself. Remember that he used Jackson Hole in August 2021 to lay the groundwork for the tightening cycle that began in March 2022. I’m thinking that Powell may use the Jackson Hole symposium next month [Aug. 24-26] to signal to the market that the rate cycle has either peaked or is in the process of peaking.

I’m not sure that the data are going to be giving the Fed latitude to raise rates two more times. The economy is weaker than commonly perceived. The stock market has not been a barometer of the economy, and I would fade that narrative. The next question will be, will Powell use the Jackson Hole symposium to prep the markets for a peak in rates, as he did in the opposite direction in August 2021?

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We are in a rare situation because 85% of the time the yield curve is positively sloped and inverted only 15% of the time. You want to be thinking about mean reversion. If the curve mean reverts, which it will, it will be led by the front end of the curve. Which means the Fed will be pivoting. The Fed always pivots, in both directions. Even if you don’t have recession in your forecast, the Fed’s own estimate of the neutral funds rate is 2.5%. We’re now almost 300 basis points above that. Just to get to neutral they would have to slice the funds rate by roughly three percentage points. That would lead to a whopper of a rally in Treasurys, especially at the front end of the curve.