Mainstream investors, both retail and professional, are fixated on inflation and are likely to be caught off guard making the wrong bet, economist David Rosenberg told attendees at Mauldin Economics’ Strategic Investment Conference.

Conference founder John Mauldin introduced Rosenberg as his “lead-off hitter” for the 13^th consecutive year of the event, which was virtual. Rosenberg “has been consistently right, because he isn’t consistent,” Mauldin said. “He is willing to change his tune.”

For his part, Rosenberg said he “unabashedly” finds himself in the same camp with Fed Chair Jay Powell. Prices for goods and services have been driven up by a combination of “fiscal juice and supply conditions associated with reopening,” he said, but that’s a transitory situation, in his view. That’s why he sees growth stocks, Treasurys and other interest-rate-sensitive assets continuing to outperform others.

Investors are likely to be surprised when the conditions for modest deflation reassert themselves by year’s end, Rosenberg argued. Many in the inflation camp fail to spell out in any detail why inflation should persist.

The supply chain disruptions currently being experienced by the global economy simply are likely to be short-lived. They certainly aren’t powerful enough to override “a trend line that has been in place for decades.”

Furthermore, the bearish view on inflation and interest rates “is already priced in” to asset prices, he said. "People will be surprised when supply catches up with demand going into the fourth quarter," he predicted.

One of the economic developments arising from the pandemic that has been overlooked is that the U.S. has seen its highest productivity growth in 10 years. Rosenberg noted that GDP fell 3.5% in 2020, while employment fell 5.5%, revealing that far fewer workers were needed to produce somewhat fewer goods and services.

In 2020, the worst year for the economy since 1946, business spending on software and IT was 6%. "Productivity is more powerful" than the CRB index, he maintained.

In addition, GDP currently stands only 1% below where it was before the recession began in February 2020, Rosenberg said. That was after an 11-year economic expansion.

The productivity boomlet may be good for businesses and investors, but it isn’t helpful to the eight million Americans still unemployed after last year’s sharp downturn. Rosenberg didn’t deny that the economy has grown after lockdown-induced 2020's collapse but he asked, “How could we not have a recovery?”

As for the labor market, the statistic Rosenberg watches most closely is the U-6, which stands at 11%. "Once it gets to 8%, I could change my mind on inflation," he said.

The real story is the government sector, where the federal budget deficit swelled from $1 trillion in 2019 to $4 trillion last year. When it comes to government spending, “even LBJ would have blushed,” he said.

“This is not an organic recovery,” he continued. “We were in a modern-day depression. Checks in your bank accounts replaced soup lines.”

Some well-informed observers like JPMorgan Chase CEO Jamie Dimon have said the economy is likely to enjoy a boom that could last into 2023. Rosenberg isn’t one of them.

The government has produced an “illusory boom,” in his opinion. Fully “80% of the economy is already reopen.”

He concedes “we will see a boom” in pent-up demand in areas that were at the epicenter of the lockdown. But travel, casinos, theme parks and restaurants represent only about $800 billion in GDP.

“We’re getting all excited about 4% of the economy,” Rosenberg said. “How many vacations, haircuts or dinners out will you be taking?”

Conversely, another side of the economy that boomed during the pandemic, consumer durables, is likely to take a hit. Consumer durables are double the size of consumer services.

“How many more times will you remodel your house or buy another dinner table?” he asked. That’s why there will be an offset to the reopening boom.

Rosenberg thinks there will be a relapse in sluggish growth in this year’s fourth quarter, as the economy returns to some sort of secular stagnation that characterized the previous decade. He noted that the consensus on Wall Street that GDP will expand at 5.0% in the final quarter diverges dramatically from the Fed’s prediction of 2.0% growth in those last months.

If the Fed is right, that “could threaten the risk-on trade,” he said. “If you are of an inflation view, you are in a crowded trade.”