Can David Rosenberg out-Roubini Roubini?
Nouriel “If you are going to be a bear, might as well be a grizzy” Roubini has a bit of competition. Merrill’s David Rosenberg now puts the odds of a recession at up to 80%
“HSBC, US Bank … now pegs the odds of a recession at 75 percent, and Merrill Lynch … says that recession odds could be as high as 80 percent.”
(hat tips: Andrew Samwick for the grizzly quip – I love it; and the Mess than Greenspan Made for Merrill's current US call, which presumably is confirmed behind the Barron’s firewall).
Roubini is still (officially) at 70% and (unofficially) at 100%. Any doubts — check out the titles of his last ten blogs. Merrill hedges a bit with “could be” as high as 80%. But Merrill is still taking a rather bearish view for a company with a bull in its logo that has long branded itself as “bullish on America.”
I always thought of the Merrill bull as an equity bull. But maybe the Merrill bull is a bond bull?
Rosenberg – and the rest of the interest rate team at Merrill – aren’t shy about the market implication of their call on the US economy. Buy Treasuries. Merrill – via Bill Cara — thinks the 5 year bond will fall to 4% in the fourth quarter of 2007.
I would put Merrill (and apparently) HSBC as the most bearish of all the big economic research shops. UPDATE: BNP Paribas belongs here too …
Goldman has some bearish tendencies, but right now is a bit less bearish on the US than Merrill and bullish on the BRICs (and on the possibility of global decoupling).
Morgan Stanley is schizophrenic. Roach is finding it hard to sustain his unnatural bullishness of this spring. Berner is still optimistic. Jen too.
Citi is pretty bullish, last I checked.
"In our judgment," writes DiClemente [Citi’s chief US economist], "growth pessimists have oversold the potential for declines in housing wealth but also have underestimated the broader health and sustainability of the current upturn." He notes that consumer spending is showing "continued resilience."
And Bank of America is also fairly bullish ….
"The Fed described the scenario in which they're very comfortably on hold," said Mickey Levy, the chief economist at Bank of America. "Moderate pace" represents a drop to "below-trend-like growth, but not any kind of hard landing; not a sharp slump" (more from BofA here)
Incidentally, the q3 BEA data suggests that a slowdown in the US was combined with a quite large current account deficit. Stephen “the current account deficit has peaked” Jen might want to take note.
A $805b (annualized) trade deficit plus a $80b (annualized) transfers deficit and a $20-40b (annualized) income deficit works out to a current account deficit in the $905-925b range, or around 7% of US GDP. That is back at the q4 2006 level. The transfers deficit is pretty much a straight line forecast, the income deficit is my estimate … but it is an informed estimate.
What happened? Shouldn't a US slump help reduce the US deficit?
A few things are worth highlighting …
- The US is flying into a real headwind – a rising income deficit requires a falling trade deficit to keep the current account deficit constant …. In q3, the trade deficit increased, and I suspect the income deficit will rise as well.
- A fall in investment (as in q3) only helps bring investment in line with savings if savings stays constant. Judging from the natoinal accounts, national savings rather clearly fell in q3 … that is how consumption growth was able to exceed income growth.
- So long as the investment slump – in this case one centered around residential investment – doesn’t spill over into consumption, there isn’t good reason to think the trade deficit will fall. The bullish case for 2007 in effect rests on strong consumption growth, falling US savings and a rising trade deficit. The bearish case expects the housing slump will morph into a consumption slump, which should lower the trade deficit — and help to keep the current account deficit constant in the face of the income balance headwind.
- If you prefer to look at things from a more micro point of view rather than a savings and investment point of view, I suspect homes have a lot more US (and Canadian) content that most goods Americans purchase these days. Especially computers and, increasingly, cars.
- The US will get a bit of help from lower oil prices in q4, but it the q3 uptick in non-oil imports continues in q4, it won't be much help. And to continue to get help in 07, oil needs to fall further.
Judging from q3, sustained consumption growth and a “sudden stop” in residential investment isn’t a recipe for a fall in the US current account deficit so much as a recipe for further falls in the US savings rate …
UPDATE: I left one of the most bearish shops of them all … BNP Paribas. Richard Iley from the comments section:
"At BNP Paribas, we have been calling for a 'hard landing' in the US economy since mid-summer and were warning that the housing boom was likely to begin to unravel via the biggest residential construction bust for fifty years at least since the end of 2005. As of July this year, we had the lowest end-2007 Q1 Fed Funds forecast on the 'street' of 4.5%. And we expect a 'hard landing' - which we define as five quarers of below 2% annualised GDP growth - rather than full-bloodied recession only because we expect such a nimble response from the Bernanke Fed to the mounting evidence of the corrosive deflation now emerging in the housing market. And our end-2007 Fed Funds forecast of 3% is comfortably the lowest of the 22 primary dealers."
BNP Paribas may out-Rosenberg Rosenberg!
A SUPERPOWER IN DECLINE
America’s Middle Class Has Become Globalization’s Loser
Der Spiegel (Germany) October 24, 2006
http://www.spiegel.de/international/0,1518,439766,00.html
By Gabor Steingart
At the beginning of the 21st century, the United States is still a superpower. But it’s a superpower facing competition from beyond its borders as well as internal difficulties. Its lower and middle classes are turning out to be the losers of globalization. …
First, Americans are so optimistic that they often blur the line between optimism and naivete. Public, private and corporate debt far exceeds any previously known dimensions. Forever piously trusting in a future rosier than the present, millions of households are borrowing so much money that they end up endangering the very future they’re looking forward to.
The lower and middle classes have practically given up on putting aside any savings. They’re going into the 21st century like a poverty-stricken, Third World family, living from hand to mouth without any financial reserves whatsoever.
I put the probability of recession at 100% because we’re still in the last one (more on this).
It’s just going to get deeper, that’s all.
Most of the supposed “recovery” since ‘01 has been based on lies, deception, and distraction.
Over the past five years of recovery from the 2001 recession, U.S. economic growth has been “asset driven,” according to colloquial language. More to the point, protracted sharp rises in house prices served private households as the wand providing them with prodigal borrowing facilities to increase their spending. For years, it was the economy’s single motor. The Fed estimates that mortgage equity withdrawals exceeded $700 billion, annualized, in the first half of 2006.
In 2005, the last full year for which data are available, new borrowing by private households amounted to $1,241.4 billion. Now compare this with the following spending and income figures. Disposable personal incomes grew $354.5 billion in current dollars and $93.8 billion in inflation-adjusted dollars. Spending increased $530.9 billion in current dollars and $264.1 billion in chained dollars.
The striking feature of the housing bubble - distinguishing it diametrically from an equity bubble in this respect - is its extraordinary credit and debt addiction. The reason is that it requires borrowing for two different purposes: first, for driving up house prices; and second, for the cash out of the capital gains. Every single dollar for this purpose has to be borrowed.
Since end-2000, American households have offset their badly lacking income growth with an unprecedented stampede into indebtedness, up so far by $5.3 trillion, or 77%. But as soaring house and stock prices added a total of $15.6 trillion to the asset side of their balance sheets, households miraculously ended up with an unprecedented surge in their net worth from $41.5 trillion to $53.8 trillion in the first quarter of 2006.
In 2001, the Greenspan Fed could cushion the fallout from the bursting equity bubble with the creation of the housing bubble. This time, manifestly, there is no alternative bubble available to be inflated to cushion the fallout from the housing bubble. Rather, there is a high probability that the popping housing bubble will pull the stock market down with it. That is the first ominous difference between 2001 and today.
The second ominous difference is that the economy and the financial system have accumulated structural imbalances and debts as never before in history. Vastly excessive borrowing for consumption and speculation has turned the U.S. economy into a colossus of debts with a badly impaired capacity of income creation.
- Dr. Kurt Richebächer
http://www.prudentbear.com/archive_comm_article.asp?category=Guest+Commentary&content_idx=59718
Schwab has joined the bears too:
“Most of the people forecasting a soft landing are counting on a boost from capital expenditures,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in New York. “I would be careful about that.” She puts the odds of a recession at more than 50-50, “and it could happen relatively quickly.”
Still the consensus is for a soft landing.
Best Regards.
The 2001 US recession was far from typical, and the recovery needs to be judged on that basis.
Based on eight recessions since 1948, in 2001 -
GDP didn’t contract year-on-year at all, not one single quarter. The average is 3 quarters. The post-recession bounce was only 1/5th as strong as usual.
Private consumption expenditure didn’t drop below +2.0% year-on-year at all, the only time since 1949 that consumer demand has stayed so strong. As a result, there was no 3-4 percentage point bounce post-recession.
Capital investment fell year-on-year for 7 straight quarters, second longest after the 1974 slump (8 quarters) and nearly double the usual four quarter drop.
Overall employment growth followed the 1974 pattern: late to slow and very late to recover.
.
I forgot who made this remark but it’s true: Morgan Stanley has representatives of every possible case–bearish, bullish, somewhere in between. Choose any investment strategy and it’s alright (presumably more so if you choose to invent with Morgan Stanley) because at least one is bound to turn up right
I remember when T-Note yield was below 4.0% in June/July 2005, Rosenberg and his gang came out and said he expected yield to remain low and possibly lower because of the long term funding needs of pension funds.
That turned out to be the bottom for yields and it has trended upwards ever since.
Before I jump on the buy Treasurys bandwagon, a first hurdle will be for T-Note yield to close below 4.6% on a weekly closing basis. Closing below 4.6% will mean more downside move ahead. If it cannot do that, look for Yield to reverse and continue with its “long term” uptrend.
“Merrill Lynch & Co. Inc.’s North American economist David Rosenberg is bullish on technology stocks. You might want to sit down and read that again. Yes, Mr. Rosenberg, known for his bearish views, is constructive on something; which in this case, is tech…”
http://www.theglobeandmail.com/servlet/story/RTGAM.20061023.wrosenberg1023/BNStory/Business/home
“Since end-2000, American households have offset their badly lacking income growth with an unprecedented stampede into indebtedness, up so far by $5.3 trillion, or 77%. But as soaring house and stock prices added a total of $15.6 trillion to the asset side of their balance sheets, households miraculously ended up with an unprecedented surge in their net worth from $41.5 trillion to $53.8 trillion in the first quarter of 2006.”
long term valuation of housing say US national prices have to fall 40% on average. (see http://www.cepr.net)
So how much is the real net worth of households ?
The figures given by guest can help.
in 2000, indebtness was 5.3/0,77 trillions : 6,9 trillions
Hence in first quarter of 2006, indebtness was : 12,2 trillons
Housing wealth in 1st quarter of 2006 was 53,8+12,2 = 66 trillions.
However this wealth is overvalued by about 40%, so the real wealth is 39,6 trillions
And the net wealth is in reality : 27,4 trillions.
It s highly probable that 80% of the 5,3 trillions added between 2000 and 2005 to the debt load will vanish in smoke.
Now, housing wealth is pretty much concentrated. It does not follow a normal distribution. Net wealth may indeed be even more concentrated (though not necessarily). So the real question is : with a national long term netwealth of 27,4 trillions (adjusted for bubble prices) : how many american citizens are technically bankrupt ? How many financial institutions specialized in mortgaged activities are technically bankrupt ? How many banks are technically bankrupt ?
Brad,
Your article seems to be based on a rather selective sample of ’street’ economists. It is normal to look at all 22 ‘primary dealers’ in the Treasury market that are usually included in the key surveys of interest rate expectations produced by MarketNews/Dow Jones/Reuters etc.
At BNP Paribas, we have been calling for a ‘hard landing’ in the US economy since mid-summer and were warning that the housing boom was likely to begin to unravel via the biggest residential construction bust for fifty years at least since the end of 2005. As of July this year, we had the lowest end-2007 Q1 Fed Funds forecast on the ’street’ of 4.5%. And we expect a ‘hard landing’ - which we define as five quarers of below 2% annualised GDP growth - rather than full-bloodied recession only because we expect such a nimble response from the Bernanke Fed to the mounting evidence of the corrosive deflation now emerging in the housing market. And our end-2007 Fed Funds forecast of 3% is comfortably the lowest of the 22 primary dealers.
Incidentally, along with RBS Greenwich, we have been the only forecasters to correctly gauge the year-end level of Fed Funds a year earlier in both 2004 (2.5%) and 2005 (4.25%) in contrast to certain economists featuring heavily in your post who basically called the peak in the Fed Funds rate all the way up.
Interestingly, RBS Greenwich and ourselves are now diverging dramatically in our expectations.I believe that RBS(along with Bear Stearns, JP Morgan and Barclays Capital) remain convinced that the Federal Reserve will resume tightening next year with some forecasters still looking for a further 75bp of policy tightening taking the Fed Funds rate up to 6%! Its been a long-time since there was such dramatic range of opinion about the path of Fed policy on Wall Street.
Assuming we’re right for the sake of argument, how would 2-year Treasury yields of close to 3% by the end of next year affect your net investment income balance ‘headwind’ on the current account deficit next year? Surely difficult to see much deterioration if bond yields tumble next year in response to a fresh easing cycle by the Fed. More generally, what is Mr.Roubini’s end-2007 Fed Funds forecast and how does this play with yours and his well-documented views on the current account?
Richard — I plead guilty to the charge of selectivity — it wasn’t meant to be a fully survey. i just wanted to have a bit of fun with Merrill’s bearish views on US economy … and highlight that the street is not a group of pure cheerleaders right now.
Do send me a copy of your forecast as well brad dot setser at rgemonitor dot com
My answer to your question about a 3% 2 year yield is a bit different today than it would have been two years ago or even a year ago — I think the evidence is now pretty good that US external lending has shorter term structure than US external borrowing, so it reprices more quickly. So a 3% fed funds/ 3% two-year implies a big fall in the average int. rate on US external lending (it has tracked the two year yield closely), from a bit over 5% (h1 06) to a bit over 3% … US external interest payments will still go up tho — the US presumably has financed this year’s $900b deficit at an average rate of 5% or more, and while lots of US external borrowing is short-term and reprices, there is enough long-dated stuff that the average rate moves more slowly. Personally, i would suspect it would even edge up from its current level of 4% on the back of 06 for the first half of 07, and only slip in the second half in the BNP scenario. The net result is still a big headwind. The benefits would start to come in 08 …
That said, the average rate on US external debt fell from over 6% in 00 to 3% or so in 03/04 — that is a much bigger tail wind than a fall from 4.25% to 3.75 or 3.5% or so … that tail wind is better than the headwind as the rate rises from 4 to 5%, but, well, it won’t compare to the 01-03 tailwind. And with a deficit of $900b in my view even with a bit of growth recession (several quarters of subpar growth), even a 3.5% average funding costs implies over $30b of net int. payments …
if you want more details on this, email me tho.
Brad,
Many thanks for the prompt and detailed response.
I have no particular disagreement with the analysis you lay out on the interest rate next year’s likely investment income ‘headwind’. I would like to introduce a wrinkle however as I think you maybe telling only half the story.
As is well documented, the US’s ability to sustain positive net investment flows for so long in the teeth of mounting external indebtedness (although it must be noted the UK continues to pull off an even more impressive brand of financial alchemy) has hinged upon a number of asymmetries but in essense has rested upon the US’s uncanny ability to earn excess returns on foreign direct investment.
Measured at current cost, returns on US FDI abroad have exceeded returns on foreign FDI by an average of 5.9% since 1976. Admittedly, this rate of return of differential has shown some signs of fading in recent years, dipping to 3.5% in 2004 before recovering somewhat to a still historically muted 4% last year. As a result, the US net investment income balance has a ‘Janus-like’ quality - with the latest data showing net FDI receipts of some $36bn broadly offseting a net outflow of a similar magnitude on net portfolio debt.
We know that gross capital outflows have continued at an impressive 5½% of GDP in the four quarters to 2005 Q2, suggesting that the US’s continues to make overseas investments at a historically stepped up rate and, with the 2005 Homeland Investment Act anomaly now out of the way, US coprorations appear to have made a cool $100 of FDI investments overseas in the first half of this year.
With US economies relative economic growth outpeformance likely to evaporate next year (BNP forecasts the US, the Eurozone and Japan all growing around 1½% next year) and the US’s once again continuing to expand its stock of net FDI after 2005’s freakish fall, surely there is a significant likelihood that a healthy pickup in net FDI receipts can largely offset the debt dynamics described above? The US currently has a net stock of a little more than $600bn of FDI. A 1% increase in the net rate of return differential next year to 5% (which would still leave it around 1% below its 30-year average) would therefore boost net investment income by some $6bn next year.
This would only a partial offset to the arithmetic you lay out above. But there is also a probable exchange-rate effect to take into account. The likelihood of US$ devalution in 2007H1 as relative interest-rate diffentials move decisively against it will only magnify this effect. A 1:40 EUR/$ rate would prove quite a shot in the arm for both the US’s cashflow and external balance sheet. A 10% fall in the US’s asset-weighted exchange rate next year would add a further $10-15bn to any rate of return effect. Given these powerful automatic stabilisers, I remain sceptical about the degree of net investment income ‘headwind’ next year. Thoughts?
The so-called “dark matter” theory of more favorable returns on US foreign investment by Hausmann and Sturzenegger has been thoroughly debunked here. Instead of evidence of an uncanny ability to extract surplus returns, it is more likely to be a mere bookkeeping artifact, among other things:
http://www.rgemonitor.com/blog/setser/124664/
http://www.rgemonitor.com/blog/setser/126311/
http://www.rgemonitor.com/blog/setser/118711/
Richard — five thoughts for now, which are a partial response to your points.
1/ The prime source of the headwind is an expected rise in the average int. rate on US external liabilities toward 5% … that hinges to a degree on stability in s-term/ l-term bond yields, as you note. But given the dynamics of a fall in short-rates work against the Us in the very short-term (as income from us lending falls faster than payments on us external borrowing), the basic headwind is independent of the interest rate path. The 1% gap I calculate between the average int. rate on US lending (5.1% in h1) and the average rate on US borrowing in the first half (4.2% in h1)is likely to fall, whether from rising US borrowing rates (rates stay at current levels) or falling US lending rates (BNP/ Merrill forecast). This differential has not been consistently favorable to the US.
And with US external borrowing (interest paying debt) likely to be in the $9.5 to 10 trillion range at the end of 06, a move from 4.2% toward 5% is a big potential headwing. Us external lending already pays 5% — i don’t expect it to go up more. The size of the headwind if US income from borrowing falls back from 5% toward 4% is a lot smaller — total US lending is heading toward $5 trillion, but the basic headwind is in the $50-100b range, over some time frame (I am not sure how quickly US external borrowing is gonna reprice).
2/ the second headwind is the obvious one — a 5% average rate on $900b in net debt = $45b a year. Say the US also borrows $200b at 5% to make another $200b in net FDI investment — in h1, the average return on FDI was around 6% by my calculations, so there isn’t a big gain ($2b).
3) Going to your point about the differential in returns converging toward is historic level, I would argue that the data suggests that returns on US FDI and foreign FDI in the US are more likely to converge absolutely than to converge to their historic spread. My numbers are a bit different than yours — but using market value for FDI in the NIIP (adjusted for 06 flows), i get a falling differential in the rate of return: 3.6% in 04, 2.5% in 05, 1.6% in 06.
4) I take your point that — if history holds — foreign returns in the US should fall if the US economy slows (that is what clearly happened in 02/03). But the current trend is for the reported return on foreign FDI to rise — largely b/c of higher reported reinvested earnings. My sense is that the BEA was embarrassed by the data, which didn’t make much sense, and is now doing a better job collecting information foreign reinvested earnings. that is a mushy argument i know, but i sort of believe it — the big gap reflected unrealistically low returns on foreign FDI, and the data is now getting better.
5) Biggest one — the huge uptick in the market value of US FDI in 05 makes it harder to sustain the big gap in reported returns. It used to be the foreign FDI in the US (valued at US market values) had a low return b/c US equities carried a big premium to foreign equities (and vice versa — US FDI abroad was valued at the p/es of foreign markets, which were lower than in the US). if sum — after 2005, the same foreign cash flow from US firms operations abroad is now valued at a much higher level, and the implied yield (expressed as a percentage of market value) fell as a result in the first 1/2 of 06. Getting the implied yield on US investment back up after the market value of that investment went way up will take a lot — a big exchange rate move raises the $ value of both the investment and the cash flow, so it helps, but not by improving the implied yield but by raising the implied stock …
so all told, I am not looking for FDI to help counter the headwind — even in a US slows scenario. There is a statistical headwind there (better data on reinvested earnings) and a market value headwind (after 05 foreign market outperformance) that makes a return to prior differentials difficult in my view.
Of course, I have gotten more than a few things about the income balance wrong in the past few years (I missed the effect of a shorter term structure of US lending initially) … so I could be off on this too.
nd we expect a ‘hard landing’ - which we define as five quarers of below 2% annualised GDP growth - rather than full-bloodied recession only because we expect such a nimble response from the Bernanke Fed to the mounting evidence of the corrosive deflation now emerging in the housing market. And our end-2007 Fed Funds forecast of 3% is comfortably the lowest of the 22 primary dealers.
Richard, why do you think that lower rates from the fed will lead to more borrowing by private actors and more money creation ?
By thinking so you assume that the debt/GDP ratio will continue to rise.
It is however at unprecedented level. And it can not rise infinitely.
So when then do you think that the Debt/GDP ratio will reach its maximum ?
I think this is the mother question of them all.