Negative growth rates lie ahead, there is no pent up consumer demand, and the Federal Reserve is "pretty much out of bullets” after cutting interest rates to 2%, warns Merrill Lynch economist David Rosenberg. In a note to clients Monday, Mr. Rosenberg suggests that in light of some tough times ahead, investors “stay conservative, defensive ,with minimal risk and minimal exposure to cyclicals and financials,” he said.
In the note, called “Pieces of Eight: Lessons We Learned Last Week,” Mr. Rosenberg makes the following observations:
1.Public policy officials remain reactive, not proactive: First, it was the Bear Stearns Co. (NYSE:BSC) takeover in March, then it was last week’s measures to save Fannie Mae (FNM) and Freddie Mac (FRE), including the Fed’s willingness to open the discount window to them and the Treasury strongly hinting at an equity investment. But these recurring bouts of financial turbulence are not over, and credit can be expected to tighten as the banking sector “deleveraging” process kicks into high gear.
2. There is no bottom in the housing market in sight:
The problem today is that the 11 months’ supply of new inventory overhanging the residential real estate market is nearly 30% more than what in the past was consistent with troughs in housing starts. We may have to see as much as a further 30% decline from here.
3. Monetary Policy is firmly on hold: The Fed is extremely concerned about inflation and would like to raise rates as soon as possible – but the tightening in credit conditions and an increasingly unstable financial market backdrop is preventing the central bank from doing so. This means a sustained deep yield curve and a dollar vulnerable to downside pressure. Mr. Rosenberg suggests a cash/gold/high-quality bond strategy in this environment.
4. The stimulus is just enough to keep U.S. economy from contracting: The tax stimulus exerted a marginal impact on spending, but just enough to prevent the economy from contracting. About 90% of the rebates have already been mailed out, leaving the consumer with little cash flow going forward.
5. Inflation pressures persist, but they are largely commodity related: The ability to pass on raw material costs through the production chain and into the consumer sphere remains severely limited. This is why inflation has emerged as the top concern for small business owners – from a profit-margin squeeze standpoint. The equity market may be technically oversold, “but the cyclical bear phase is very much intact.”
6. Global growth is cooling off visibly: Manufacturing production in both the Eurozone and Japan declined last quarter. In Europe, Spain, Ireland and Denmark are either already in recession or are on the precipice. Italy is stagnating and France is weakening. Germany has also begun to falter. And the U.K., coming off its steepest increase in unemployment in sixteen years and deepening declines in home prices, looks to be no fewer than six months behind the U.S. on the road to recession.
7. Declining demand is why crude oil is on a losing streak: The decline in demand is very much at play behind the fact that crude oil went on a four-day losing streak to below $129 a barrel.
Weaker demand is finally showing through the inventory data – U.S. consumption is down to a five-year low... and gasoline usage is falling at its fastest pace in 17 years.
8. The 2008 economic backdrop has played out in reverse. Mr. Rosenberg’s GDP growth forecast for the year remains little changed at 1.5%, but it now appears as thow it was front-laded in the first half. But a relapse appears in store for the second half as well as 2009, as the nonresidential construction boom comes to an end, the banks cut back on pre-arranged credit lines,and the problems of Fannie Mae and Freddie Mac and failure at IndyMac will reinforce the declining availability of mortgage credit and overall tightening in financial conditions.