David Rosenberg: Recession in 2022 Will Drive a Bear Market
The U.S. economy will be in recession in the second half of this year, according to David Rosenberg. Equity Investors should brace for a 30% bear market decline.
The Toronto-based Rosenberg started his own economic consulting firm in January 2020, Rosenberg Research & Associates, after working a decade as chief economist and strategist at Gluskin Sheff & Associates. He was the opening speaker at this year’s Strategic Investment Conference, hosted by John Mauldin.
Recall, however, that Rosenberg spoke at this conference two years ago, when he proclaimed that U.S. equity market bulls were in “fantasyland.” He was wrong. The return for the S&P 500 for the following year was 56.25%. He delivered the opening keynote again last year. He forecast that inflation would subside and was bullish on government bonds and growth stocks. None of those forecasts were accurate.
Rosenberg said that the U.S. economy has been hit with health (COVID-19), war, inflation and monetary policy shocks. The next shocks will come from the housing market, followed by a “wealth shock.”
“We should all be worried,” he said.
There has never been a recession that was not accompanied by a bear market in stocks, according to Rosenberg, and the average decline has been 30%. The S&P 500 was down 13.4% year-to-date on the day he spoke.
At the beginning of the year, he said that every valuation metric was at “two-sigma” levels. “We are paying the price for that now.”
“The market internals have the story right,” he said.
Fiscal policy will weaken the economy. A year ago, fiscal stimulus was adding 5% to economic growth. By the end of this year, he said the effect will be -2.8%. “This will be a huge contraction on demand.”
The last time the Fed embarked on a tightening cycle, Rosenberg said, “markets leapfrogged them.” Fed Chair Jerome Powell has become the modern-day Paul Volcker. He and other central bankers know how to kill inflation, Rosenberg said, and have the tools to “crush domestic demand.” The Fed cannot influence supply, only demand.
“We had a huge asset deflation under Volcker,” he said, “and we are in the early stages of that now.”
There have been 14 Fed hiking cycles and 11 resulted in recessions, according to Rosenberg.
Echoing his comments from a year ago, Rosenberg said that inflation will soon subside.
“I cannot believe how everyone is freaked out about inflation,” he said. Demand is not that strong, he said, and only appears that way relative to anemic supply, which is a very unusual condition. Concerns around supply-chain bottlenecks and increased power among workers are “radically overdone.”
Inflation is not about demand, he said. It is about supply shortages tied to Russia and Ukraine, and from China closing its ports. But when food and energy inflation go above 8%, we go into recession, he said.
“The Fed will destroy demand and will be the inflation antidote,” Rosenberg said.
Companies have used this bout of cost-push inflation to boost margins and are guilty of “price gouging,” he said. The corporate sector has put four years of price increases in one year. But consumers are catching on and resisting.
There is no wage-price spiral like in the 1970s, according to Rosenberg. Indeed, he said real wages are “bottled up” and at a three-year low.
We are late in the cycle, he said, “in the eighth inning. We are 82% of the way through the cycle, even though it is only two years old.” This pattern happened in the early 1980s, when the Fed did not tighten early in the cycle, which it normally does in the equivalent of the third inning. “We usually have a long runway,” he said. Only once, in 1999, did the Fed raise rates this late in the business cycle.
The yield curve confirms Rosenberg’s recessionary prediction. It inverted in August 2019, and he said we would have had a mild recession in 2020 even without the pandemic. It inverted again on April 1.
The yield curve and unemployment rate are the most important economic barometers, Rosenberg said. The recent yield-curve inversion indicates there will be an “outright or growth recession.” Unemployment will “hook back up,” he said. An unemployment low precedes recessions by about eight or nine months, and it peaks right after the recession ends. Expansions historically last 70 months, but this one will be a lot shorter.
How to invest
It is about defensiveness in stocks and increasing credit quality in bonds, according to Rosenberg.
Cyclical stocks are already in a bear market, he said, and their performance resembles the onset of the last three recessions.
Real estate and commodities will be beaten down, he said, and the time will come when to buy them. Avoid emerging markets, commodities, and junk bonds, he said.
He recommended defensive sectors, like utilities, even though they have recently hit new highs. Investors should own dividend-payers in non-cyclical industries, government bonds and volatility.
“The liquidity cycle is changing,” he said, “and you need to be extremely cautious and defensive.”
The futures market is priced to expect 3% on the Fed funds rate. The last time rates rose by 2%, the equity market went down 20%. But he said the Fed could be “done by July,” since it does not want to “put the economy into a tailspin.”
Bond yields go down an average 150 basis points in recessions, Rosenberg said. “There will be a flight to safety, even if inflation remains elevated.”
He cautioned that his views are for those investing with a time horizon of the business cycle. Others, like Warren Buffett, look beyond the business cycle and focus on the long term.
“This is no time to become emotional,” Rosenberg said. “It is time to protect your customers.”
Robert Huebscher is the publisher and CEO of Advisor Perspectives.