David Rosenberg – A Near-Certain Recession in Q2
The odds of a “hard” recession are 99%, according to David Rosenberg, and it will start in the second quarter. Indeed, he said, it may have already started.
“There is a 1% probability of a soft landing,” Rosenberg said.
Rosenberg was the opening keynote speaker at John Mauldin’s Strategic Investment Conference, an event that I have attended for many years, both virtually and, in prior years, in person.
Rosenberg is the president and chief economist and strategist of Rosenberg Research & Associates Inc., an economic consulting firm he established in January 2020. Prior to Rosenberg Research, he was chief economist and strategist at Gluskin Sheff and Associates Inc. from 2009 to 2019. From 2002 to 2009, he was chief North American economist at Merrill Lynch in New York.
Before I look at what Rosenberg said, let’s go back to his keynote at this conference a year ago. He wrongly predicted that the U.S. would be in a recession in the second half of 2022 and equities would suffer a bear market with a 30% decline (the actual return was -18.01%). He wrongly predicted that housing prices would decline in 2022 (the Case Shiller index was up last year), but he correctly predicted that inflation would subside. He was somewhat correct to call on investors to be “defensive” in stocks, but wrongly predicted that bond yields would go down.
As I noted in my article covering that talk, he was similarly wrong in the keynotes he gave in 2021 and 2020.
Rosenberg’s outlook is centered on historical data and the reliability of indicators, such as an inverted yield curve, to predict economic and market behavior. He claimed that the “business cycle is not dead” and, as in the past, we are due for a recession as the natural follow up to the post-pandemic recovery.
He was critical of the Fed for behind “behind the curve” and failing to tighten soon enough. According to Rosenberg, Fed Chair Jay Powell was wrong a year ago when he said that the probability of a recession was “not elevated.” But the then-inverted yield curve implied a 25% probability of a recession. In December, Powell said the odds of a recession were “not knowable,” but, according to Rosenberg, the probability was 75% then and has gone up since.
There have been 14 rate-hiking cycles since World War II, and Rosenberg said 11 of them caused a recession. If you deny the predictability of that relationship, then, according to Rosenberg, it is like, “Someone looking you in the eye and telling you your kid is ugly. Nobody wants to believe it.”
The three instances when rate hikes did not trigger a recession were in the 1960s, 1980s and 1990s. But he said that in those instances the Fed “knew when to stop” and did not tighten when the yield curve was inverted. The inverted yield curve is the bond market’s way of “saying uncle,” Rosenberg said.
What matters most is interest rates, Rosenberg said, and the 500 basis points of increases in the last year have historically been made over two to three years. “We will look back and say the Fed overdid it,” Rosenberg said.
“The Fed has gone too far,” Rosenberg said.
The University of Michigan consumer survey readings are ominous. Spending intentions are below the worst level among all recessions since 1982.
Housing and automobile inventories have recovered from pandemic-related shortages, but high financing costs are slowing consumer spending, Rosenberg said.
Rosenberg said he doesn’t know if the “story is fully played out” in the banking sector, and that there is a probability that contagion will follow. “At the end of every Fed tightening cycle there is a financial event of sorts,” he said.
The biggest danger lies in credit tightening. He said the economy is driven by credit and banks were tightening before the collapse of Silicon Valley Bank. There is a 70% correlation between tightening and business-capital spending, according to Rosenberg.
There are early signs of 30-day delinquent payments by consumers, which he said is a precursor of defaults.
Repeating his prediction from last year, Rosenberg said the recession will cause earnings and multiple contractions that will drive equity prices down 30%. We are heading into a “meat grinder, volatile” market that will be sprinkled with bear-market rallies, he said.
But bonds will do well, he said, and his strongest conviction position is that “bond yields go down in a recession.” “There is a flight to quality in recessions,” Rosenberg said.
He expects inflation to subside to 2% by next year and does not believe in “structural inflation” that is caused by deglobalization and increased worker power.
The Fed’s actions on May 3 will be its last rate cut, he said. “We could be at the zero-bound on the Fed funds rate if I am right about the recession and inflation.”
“That is why I am bullish on bonds,” he said.
He said that stocks will “retest their October lows” (3,583 in October 2022 versus 4,120 now) and will rally in 2024. “Be patient,” he said, and wait for the yield curve to de-invert. “The stock market needs the bond market’s help. And the bond market needs the Fed’s help.”
Even though Rosenberg has been wrong for several years and deservedly has a reputation as a “perma-bear,” eventually he will be right. But I am skeptical of his reliance on history as predictive of the business cycle, particularly when looking at data that is three or more decades old. Our economy has become progressively more dominated by the service sector. In 1959, roughly the same number of people worked in the services and goods-producing sectors of the economy. Now there are five times more workers in services than in goods.
The services sector is not nearly as vulnerable to interest rates or to shifts in capital spending as the goods-producing sector. This is why the volatility of U.S. GDP has decreased steadily as services have become more dominant. Barring an exogenous event such as the pandemic, it is unlikely we will see the hard recessions or exceptional recoveries we saw 30 or 40 years ago.
Rosenberg said the business cycle is “not dead,” but it would be more accurate to say it has retired to a place where it enjoys a far more sedate lifestyle.
Robert Huebscher is the founder of Advisor Perspectives and a vice chairman of VettaFi.