David Rosenberg catches a lot of flak for being excessively bearish about US equities, however, there have been a lot of good calls within his commentary over the years. One of the best calls has been his outlook for inflation. While many commentators have called for hyperinflation or a 1970’s style inflation Rosenberg has remained staunchly at the opposite end of the of the spectrum. And to this day, he still says deflation is the principle risk. In his most recent note Rosie elaborates:
“There was no shortage of press articles over the weekend attacking the enemy – the bond market. After all, for the typical equity market portfolio manager who is overweight this market, it must be a nagging feeling going home every night now seeing bonds yields lower – a clear non-ratification for the near-universal view of sustainable growth in the economy and earnings. At a time when the Fed is incrementally withdrawing, the extent of the fiscal drag at all levels of government should not be underestimated…
Meanwhile, sentiment towards bonds remains deeply negative (which in market parlance is a “contrary positive”). See Own Government Bonds? Here’s Something Else To Fret About on page B1 of the weekend WSJ. And Treasurys Gains at Risk on page C2 of yesterday’s edition. Or how about the article on B7 – Municipal Bonds Have Surged – But Investors Need To Be Skeptical. Here’s Why. This second article draws the conclusion that “the problem is that the trend could easily reverse. With rates this low, the best-case scenario is that they remain flat; the worst and most likely scenario is that they will rise” (although nobody seems to be very concerned over the corporate market, even though we just came off a week of record supply issuance of $30 billion last week!).
Geez – didn’t we hear that sort of talk all last year? And what do we have? A 10-year note yield pervasively stuck in a 2-4% range. And here we have the end of government support for risk assets, the global economy cooling off and commodity inflation peaking out. Worries over Greece are also giving a lift to safe0havens and the 10-year yields in Greece moving above 16.5%, it would seem a safe bet to say that the markets are bracing for some sort of default, even if couched in more palatable terms….
And event, the 3.07% yield level for the 10-year note would represent a key technical break – where the 200 day moving average resides. Mortgage convexity would then very likely take the yield down to 2.9%. And the rally we are seeing of late in the Treasury market is occurring on the back of renewed deflation pressure – the 5-year CDS spreads, measuring US government default risks, actually widened 10bps last week to 51bps.
Of course, deflation is now going to rear its head again. Oil prices are down 13% from the nearby peak. The base metals complex is down 10% from the recent high as well and trading both below the 50 and 200 day moving averages. The agriculture price sphere has corrected 10%. Gold is off the boil and silver has plunged 35%. Deflation is the principal threat, not inflation.”
Of course, I agree to a large extent. All of those cries about the bond bubble last year and hyperinflation have turned out to be dead wrong. The current environment is not consistent with past hyperinflations or even periods of high inflation. What is boiling beneath the surface is the balance sheet recession, however, the USA has done enough spending to fend off this beast for the time being. That said, the risk is still not hyperinflation in the USA. In fact, I believe the risk of hyperinflation remains close to nil. At the beginning of the year I said we were likely to experience inflation in the 2.5% range this year – higher than what I had been calling for over the last 2 years, but lower than the historical average. That’s been pretty close to dead right so far. I also think Bernanke is likely to finally get something right – this surge in inflation (mostly due to motor fuel prices) is likely to be transitory.
As for bonds, Rosenberg has nailed it. You can’t be super bearish about bonds unless you believe in one of two scenarios – hyperinflation or booming growth. Ironically, the paper bears don’t understand that the history of hyperinflations (as previously covered here) is not even remotely consistent with the current state of the US economy. So, the only way they will likely be right about bonds is by being wrong (about US economic growth). And while I’d love to be a believer in booming growth I just don’t see the USA experiencing strong economic growth with such enormous slack remaining in the economy and the increasing likelihood of austerity in the coming years. We remain deep in the balance sheet recession and until policy makers recognize that the likelihood of stronger growth is very low. And because of this malaise and persistent government ineptitude (around the globe) US bonds will continue to perform just fine.
Source: Gluskin Sheff