Many market participants are viewing the rotation out of growth and into value as a signal that a degree of reason is returning to the U.S. equity market. Former Merrill Lynch chief North American economist David Rosenberg begs to differ.
“When I hear this is an earnings-driven rally I have to chuckle,” Rosenberg said in a video yesterday. If this were really an earnings-led bull market, “the arithmetic shows the S&P 500 would be sitting at 4,800 right now, not 5,600.”
According to his calculations, the current leg of the market surge that started in late 2022 has been one part earnings-driven and three parts multiple expansion, taking the S&P 500 forward price-to-earnings multiple to 22. “This goes down as one of the top decile” valuations of all time, prompting the proprietor of Toronto-based Rosenberg Research to quip, “What me worry?”
Investor sentiment and animal spirits are sitting near historic levels, leaving investors highly vulnerable, he continued. His greatest worry is “how nobody has rebalanced their portfolio” in this latest stage of the run. “It’s as if diversification is a dirty 15-letter word,” he stated.
What’s most alarming is that equities now account for more than 70% of the U.S. household balance sheet, he said. “For the retiring baby boomer community over 60% of their asset mix is in equities, which is double where it should be at this stage of their lifecycle,” he argued.
More than a few retirement experts would disagree with that statement, taking the position that many individuals are living longer but not always healthier. And while many Americans have just recently discovered or rediscovered mainstream inflation, persistent healthcare inflation has been a constant for 40 years. As many advisors will counsel, equities are one of the few asset classes that allow people to retain their purchasing power over time.
However, Rosenberg thinks the composition of the stock market, with over 50% of it sitting in passive funds concentrated in a handful of stocks, resembles the “tech mania” of the late 1990s. “We all know how that turned out,” he said. But “you can’t warn” investors when “everyone lives in the moment” and extrapolates recent returns far into the future.
The heavy participation by people over 60 in “risk assets at nosebleed valuations” is a “deep concern for me,” raising the stakes for the next bear market, he said. The baby boomer generation “has been this 80 million pig-in-the-python that has been the dominant force in the economy” for the past five decades.
That’s why the next bear market is going “to carry with it a retirement crisis of epic proportions,” Rosenberg declared.
So far in the current decade, the consensus call among economists for a recession that began when the Federal Reserve started hiking interest rates have been wrong. One reason some other economists like Ed Yardeni believe the U.S. has managed to dodge a downturn is the wave of baby boomers leaving the workforce and entering the so-called go-go years of retirement.
Even as the Magnificent 7 stocks have started to sputter this past week, Rosenberg concedes that the headline indexes have held up reasonably well. However, the rotation into value and small-cap stocks has been the fastest he has ever seen, prompting him to be skeptical.
“From my lens, there is nothing fundamental or rational here," he said. "It’s more of a trade than a trend. Maybe we can boil it down to the Trump trade.”
Historically, value and small-cap shares tend to be “positively correlated” to interest rates, inflation and economic growth. “All three—interest rates, inflation and economic growth—are actually headed in the other direction,” he noted.
He advises investors to diversify into other geographies such as Japan and India, both of which have “secular tailwinds.” And Rosenberg continues to pound the table for Treasury bonds and notes since the Fed easing cycle is around the corner.
At present, the economy is facing a situation where the most cyclical components of the Consumer Price Index are “not disinflating, but deflating outright,” he said. Rosenberg also expect the U.S. dollar to weaken as the central bank starts cutting rates. That is a key reason why “the bond-bullion barbell is alive and well, and deserves consideration in anyone’s asset mix, especially at this time,” he said.