According to expert Dave Rosenberg, were in a reality with a dramatically weaker global economy. He shares his insights on what investors should do during this period of uncertainty and rising volatility.
June 3, 2011, 6:24 a.m. EDT
By Jonathan Burton
SAN FRANCISCO (MarketWatch) — This is the world according to David Rosenberg, chief economist and strategist at Toronto-based investment manager Gluskin Sheff + Associates Inc.:
It’s a world of disinflation, not inflation — a reality of a dramatically weaker global economy. In this climate, U.S. bonds rally as interest rates remain low or even decline. Not only corporate bonds, which reflect the strong financial shape of U.S. companies, but also Treasurys and municipal debt.
Slow economic growth pressures U.S. and international stocks, except for cash-rich companies that boost dividends, plus shares of oil, natural-gas and agriculture producers.
Uncertainty and rising volatility is also good for gold, which finds new life among central bankers as an alternative form of currency that pushes its price to $3,000 an ounce.
“All the economic data is starting to roll over,” Rosenberg said. “We are positioned for the type of disinflationary slowdown that we’re going to be seeing over the next 12 months.”
Rosenberg, the former chief North American economist at Bank of America-Merrill Lynch, has a reputation for being skeptical of Wall Street’s generally optimistic nature. Yet he’s not predicting gloom and doom for stocks. What Rosenberg does expect is a less forgiving environment where capital preservation and income are prized, and careful stock and sector selection is paramount
1. Little to no inflation, so buy Treasurys
When it comes to the outlook for Treasurys , Rosenberg is squarely on the opposite side of the fence from Treasury bear Bill Gross, the Pimco bond king who just this week said current Treasury yields do not compensate investors for the risk of holding them. Read more: Gross warns on Treasurys again.
Rosenberg said he’s baffled by Gross’s view. “I’ve never understood ... the negative case for Treasurys,” Rosenberg said. “What is the weakest part of the U.S. economy? It’s housing. If you want to be bullish on the economy and the housing sector, be bullish on interest rates. How else are we going to get the housing sector going?”
Low interest rates would be a byproduct of a cooling U.S. economy. So would low inflation. Rosenberg said he just doesn’t buy the argument that inflation will ravage the U.S. economy. Yes, he acknowledged, prices are rising for essentials — oil, food, energy — but inflation isn’t nearly as pronounced in the service sector and, crucially, Americans spend the bulk of their income on health care, financial and other services.
“This time next year inflation is going to be between zero and 1% from over 3% now,” Rosenberg said.
What happens to Treasurys then? UST10Y -0.86% Only good things. “Who’s got 1% inflation in their forecast?” Rosenberg said. “That will come as a very big and pleasant surprise for the Treasury bulls.” Read more: Greece, Moody's threat, weigh on Treasurys.
2. With changes in state pensions, own munis
Municipal bonds have been relegated to the debt-market Dumpster. Predictions of hundreds of muni defaults grabbed headlines and panicked investors, to the extent that muni-bond mutual funds have seen shareholders stampede for the exits over much of the year.
What the muni-bond bears have failed to appreciate, Rosenberg said, is the resolve of state governors and city mayors, Republican or Democrat. “Default was not an option,” he noted.
Instead, governments have raised taxes and extracted unprecedented concessions from government workers in an effort to bring generous public-sector pensions more in line with those of the private sector, Rosenberg said.
The strategist advises selective buying in the municipal market, however: “I like the bonds that are backed by a revenue stream that is not cyclical, in states or municipalities that do not have a problem with underfunded pension liabilities.”
3. Find cash-rich companies and buy their bonds
One reason why the economy is weak is that companies have been hoarding cash, Rosenberg pointed out. Capital spending is tight and that leaves corporate coffers fuller and corporate managers with a great deal of flexibility to run a business, service debt and provide for shareholders.
For an income-seeking, yield-hungry investor — and Rosenberg is convinced that the baby boom generation and even many younger investors are increasingly of that mind — steady bond payments coming from a cash-rich balance sheet are highly attractive, Rosenberg said. (Shares of companies that increase dividend payouts are an exception, he added, but the cash-based rationale is the same.)
“We are living in a period of economic and financial history, and the book on the post-bubble credit collapse hasn’t even been written,” Rosenberg said. “It’s extremely important to be diversified and to focus on capital preservation and cash flow.”
For the greatest potential return, Rosenberg said to focus on the highest-quality part of the non-investment grade bond market. Specifically, he said, these are issues rated “BB,” but with a balance sheet that looks as if the bond should be rated single-A.
4. Drill into oil and natural-gas stocks
It took only a couple of years for oil prices to climb back above $100 a barrel from the most devastating recession since the Great Depression and such powerful demand isn’t lost on Rosenberg.
“I’m very bullish on oil,” he said. Dividend-paying oil-company stocks — including shares of energy services, drillers and major multinational producers — fit neatly with Rosenberg’s income-seeking, capital preservation formula.
“The secular trend line is intact,” he said about oil. Rosenberg favors energy-services firms, particularly onshore and offshore drillers. He also likes natural-gas operators with substantial reserves.
5. Buy gold; it still has the Midas touch
It seems odd that a strategist who sees no inflation looming is a gold bug who expects the metal’s price to double.
Except to Rosenberg, gold isn’t behaving much like an inflation-fighting commodity. Instead, the strategist said he’s struck by gold’s growing status as an alternative to paper currency. Asian central banks, for example, are allocating more reserves to gold — “a whole new source of demand,” Rosenberg explained.
Yet since gold production isn’t rising to meet that demand, the metal’s future is bright, Rosenberg noted.
“Gold can double from here in the next couple of years,” he said. “I could easily see $3,000 an ounce before it morphs into a bubble. Is there still money to be made being involved in bullion and gold-producing stocks? The answer is yes.”
Jonathan Burton is MarketWatch's money and investing editor, based in San Francisco.
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