ED HARRISON: Welcome to Investment Ideas. I'm your host, Ed Harrison. Today, we are in Toronto for our latest edition of Investment Ideas. And we are talking to chief strategist of Gluskin Sheff, David Rosenberg. He's going to talk to us about how his positions from June have moved, whether those investment theses have played out.
And he's going to talk about where he sees investment opportunities going forward. And he's told me ahead of time that he has a specific very interesting idea that you won't want to miss. He hasn't told me what it is, so I don't know myself. I hope that it's interesting, and I hope that you enjoy what we have to say.
David Rosenberg, we're here in your town, Toronto, talking to you about what's happening, about the calls that you made before. But I want to talk also a little bit about Canada and, looking forward, whether or not it's the same view. Last time we were talking, I think you were talking about defensives on the one side, and you were talking about bonds, long bonds in particular, on the other side. Do you still think that that's a good call? And what are you seeing?
DAVID ROSENBERG: Right. Well, I think that the bond market call is intact. It's not going to be a straight line, but the reality is this. We've come a long way in terms of what, say, the 30-year treasury yield has done, going from 3% a year ago down towards 2, the 10-year note down towards 1.5%. But guess what? The recession hasn't even started yet, and there has never been a time historically where yields out the curve fail to go down in the context of an outright recession.
ED HARRISON: And by the way, you said yet, whereas last time we were talking, you were talking about the capex recession. Now, you're talking about a real recession, potentially, coming forward.
DAVID ROSENBERG: Right. Well, you know, it's-- you have to take a look at GDP as almost an organism. It's like a living thing. And just like the human body, you don't shock one part of it without there being some impact on other parts of it. So this view that somehow we get a capital spending recession and there wouldn't be some knock-on effects, it's called actually, in economic terms, it's called partial coefficients. Every part of GDP is correlated, and it just lags.
And it sort of reminds me of the time, you know, back when I was at Merrill, 2007, people were saying, oh, don't worry about housing, it's such a small share of GDP. But people failed to take into account all the powerful multiplier impacts on the rest of the economy. Same thing with capital spending. So the capex recession, companies don't just cut capex without a lag, if they don't see an improvement, cutting other things, like hirings. That's one of the reasons why employment growth is slowing down so dramatically. And in fact, of course, firings aren't that high because there's such a shortage of skilled labor that companies want to hoard their best employees. And you're seeing that in the jobless claim numbers.
But remember that non-farm payrolls are a net number. It's hirings minus firings. And hirings, no matter what measure you look at, have peaked for the cycle. So companies are cutting back on hiring plans, and that's why this view that the consumer is going to stay resilient is, I think, a very dubious view as we move into the balance of the year, and then in 2020.
ED HARRISON: So when we spoke, we were talking in the sort of mid-June phase, we had sort of a 12 to 18-month topping-- or bottoming, and then, you know, back to square one on the equities front. And we saw 10-year yields for the US at, like, 190, something of that range.
DAVID ROSENBERG: Right.
ED HARRISON: Right now, equities are pretty much a push, but bonds are doing really well. How does that scenario play out going forward?
DAVID ROSENBERG: Well, it's interesting that, you know, the stock market, the glass is half full, as that we're only a few percent away from the all-time highs, if you look at the S&P 500. Now, the S&P 500, by the way, is not the only index out there. I mean, the Russell 2000 is actually back in deep correction phase. You look at the transport stocks, they're in deep correction phase.
And in fact, you know, we, in my economics department, construct an in-house equity composite that's purely economic sensitive, just the cyclicals. Deep in correction terrain. So essentially, they have a stock market that's been held up towards the highs because of what sectors? Utilities and staples and health care, the sort of stuff that you want to own in an economic slowdown.
ED HARRISON: The defensives.
DAVID ROSENBERG: Right. And of course, look, you've had some segments of big tech, you know, taking away some of the political attacks on the sector, but use Microsoft as your bellwether for defensive growth in the technology sector. So my thematic really within the stock market has been classic David Ricardo slash Adam Smith scarcity value. Own what's scarce.
So what's scarce? Globally, yield is scarce, as 30% of the global bond market trades with a negative yield. Yield is scarce, so own income equity. Dividend growth, dividend yield, low payout ratios, strong balance sheets, non-cyclical. That's a part of the stock market I actually like. And barbell that with what is the other deficiency, the other scarcity is growth. So you want to own growth. And that's why Microsoft has done so well. You want to own growth stocks, and you want to own income-producing stocks.
ED HARRISON: Right.
DAVID ROSENBERG: And that's one part of the stock market. The stock market overall, I think, has actually done quite poorly. Even though we're not in a classic bear market, we're in a classic topping formation. And the reality is that, if you're looking over the past year, the bond market returns have been so dramatically superior to the stock market returns. And that's something people would normally talk about. When you turn on the television set and you watch, you know, all of the business and market shows, you'd think the stock market is the only asset class in town.
ED HARRISON: Right. Definitely.
DAVID ROSENBERG: The bond market, meanwhile, in terms of market cap, is infinitely bigger than the stock market. But bond market returns, especially long-duration treasuries, have been a great place to be. You know, it's funny because, a year ago, people would say what idiot, what idiot would buy--
ED HARRISON: Right.
DAVID ROSENBERG: --a 3% 30-year treasury? What did-- as if people actually hold onto that to maturity. You know, they're not like a pension fund or insurance company that have to do any asset liability matching. You don't have to own a 30-year bond for 30 years, or a 10-year bond for 10 years. You know, the duration of the stock market, by the way, is 50 years. Do people-- I mean, I hold a stock for the long run, but who holds a stock for 50 years? Not many people.
So it's funny that when people say to me, well, who would have bought a long bond at 3% a year ago, what idiot, and my response is, yeah, well, the idiot that wanted to get a 25% total return. That idiot wanted to buy the 30-year bond last year. That's the sort of idiot. So people don't understand that relationship that we talked about earlier, that relationship between yield and price in the bond market, and the power of convexity at these low level of interest rates.
ED HARRISON: That's interesting. You know, actually there were two other things I wanted to go off on in that, but when you mentioned convexity, immediately the conversation came to mind-- and I told you about this-- I talked to a German investor, Philipp Vorndran, who's a-- used to be a asset manager for Credit Suisse.
And he was basically saying that the last 150 basis points of yield in Europe, from 150 to 0, is-- it was massively convex. And it caused a shortening in duration. People were bidding simply to keep their duration constant. And they were caught out by that. We're really right at that point right now. 150 basis points. You know, that's where the 10-year is as we speak.
DAVID ROSENBERG: Yeah. Well, I think that, you know-- I mean, that's a-- you know, let's call it a focus on the curve and focus on the carry and focus on those inflection points from a technical perspective, let's say. From a fundamental perspective, you know, and again, people say, well, who would buy these German bond yields with a negative coupon, well, here's the deal. It comes down to inflation expectations. It's only been in the past couple of months that people have woken up to the-- I wouldn't say prospect, the reality of a German recession.
That's a pretty big deal, right? I think globally, when you think about-- we just talk about US and China. We don't talk about-- we talk about Brexit, but Germany, Germany is the largest economy in Europe. It is the engine. And it's only, in quotes, only the fourth largest economy on the planet. And it's going into recession at a time when inflation there is zero.
And people do the arithmetic and say, gee, it's interesting that, when Germany goes in a recession historically, guess what, their inflation rate declines by three percentage points. So people will say, well, who would buy, like, a negative 0.5% 10-year bund yield? But actually, if your view is that we're going to recession in Germany and inflation is going to go from zero to negative, your real interest rate is 2.5%. Your real rate.
People always say, well, the real rate-- people calculate the real rate on the 12-month trailing trend of inflation or underlying inflation. Why on earth would you ever use the 12-month trailing trend on inflation for your real interest rate? Because by definition, the real rate is based off inflation expectations. Where it's going, not where it's been. So I think that actually there's a lot of people out there buying German bunds because they see a deflationary experience coming ahead of us.
And I'll tell you something else that I think is very material from a global perspective, because it's really been a global meltdown in yields this year. It's been a global meltdown in yields. And what's happened is that this was the first time ever that we had a global economic expansion that failed to close the output gap. So this is a 10-year expansion. This is the only time ever where aggregate demand did not surpass aggregate supply. That never happened, we fell short.
Then what else do we know? We know that the OECD leading indicator, OK, has declined for 19 consecutive months. Oh, people say, oh, but the declines are getting more marginal, but it's still going down. So what those two numbers are telling you, the OECD leading indicator is still in a downtrend, oh, by the way, only the lowest level since 2009, coupled with the fact that the output gap never closed means that the output gap is going to widen in the next year, the deflationary pressures are going to intensify. And I don't know many times in my career, or looking back before my career, where a deflationary experience failed to prevent long-term interest rates from going down from whatever level they're at right now.
So as low as these yields are, they're going to go down. And especially in the US, because the US right now, I mean, he's the smartest kid in summer school. And I think that you're going to see interest rates go down quite a bit more from here. And that's where the total returns are going to be.
ED HARRISON: Now, the pushback on that would be that, you know, we spoke to-- I didn't speak to him, but we had Real Vision spoke to Rich Bernstein, your former colleague at Merrill.
DAVID ROSENBERG: I love Rich.
ED HARRISON: And what he was saying is that actually, if you look at the data, China is leading in terms of bottoming. Europe is following. And then the US, while still bottoming, will follow later. That's the read that I got from what he was saying.
DAVID ROSENBERG: Bottoming in terms of economic activity?
ED HARRISON: Exactly.
DAVID ROSENBERG: I just don't see it. I just don't see it. You know, I think that actually the people that make a living out of following China are actually cutting their numbers to below 6% for the coming year. I'm not seeing that in the leading indicators, but, you know, I follow China because, of course, it's such a key component of the global economy, but I am no China expert. But I'll tell you, I know China experts, and China is not turning around. Where? Europe is turning around. I mean, we just got these horrible ISM numbers.
ED HARRISON: Right.
DAVID ROSENBERG: Horrible orders. And Germany and the UK and Italy are all either in recession or heading into recession. And now France, which, for whatever reason, had been hanging on by the fingertips, and now France is weakening, especially its service sector. So all I can say is that I don't know what data points Rich is looking at, but they're not data points I'm looking at.
ED HARRISON: Right. So what's the policy response there? Especially I'm really interested in Europe more than anything else, because they have their hands tied, in certain ways. I mean, people are talking about fiscal stimulus and things like that, but when you have interest rates at, you know, negative 70 basis points, and you're talking about going even further into the negative, how is that going to help in any possible way? So what can they do to arrest the deflationary impetus that you're talking about?
DAVID ROSENBERG: Well, for one thing-- and it's not every single country, but say Europe writ large, the banking sector there is still very weak and undercapitalized. Point number one. And there's no easy solution towards resurrecting a normal functioning banking system. In terms of what could be done, well, there is a negative exogenous shock that everybody is facing-- I mean, even here in Canada-- which is this global trade war.
And it's not just anymore-- it's not the US and China, it's now US and the EU, and with the WTO will then give Europe the opportunity to slap tariffs on the US next year. And all this started even before, you know, China, with Mexico and with Canada and with Japan, and tariffs on steel and aluminum, softwood lumber.
So look, we had a precedent in the United States that ran on this campaign of trade deficits are evil, they're stealing jobs from the US. And it's created this massive disruption in global supply chains, and also this big withdrawal in global production growth. And the trade-sensitive parts of the world have suffered from it, Canada being one of them.
But look at it, Germany is actually a huge exporter. So the bigger your export quotient as an economy, you know, the tougher it's been. So if you're going to tell me we're going to have some massive kumbaya moment, never mind just a US-China trade deal, but all the tariff increases everywhere are going to be rescinded, how's Donald Trump going to do that and save face with his base?
ED HARRISON: Right.
DAVID ROSENBERG: And this is something-- if you go back to Donald Trump in the 1980s, this is something purely ideological. It's going to be tough to back off from the uncertainty created by the global trade war. And it's not just Europe, but it's actually the global economy that's actually slowing down. Germany happens to be very export sensitive.
And I think that the Brexit concerns, you told me they were going to sell Brexit, well, that'll help ease some of the uncertainty, too, over in Europe. But this notion somehow that fiscal policy stimulus or infrastructure, the 13-letter word for motherhood, where are you going to get the workers? Are we going to have-- like, this is what's interesting, right, is that the world is tearing itself apart.
Look at society. Look at the xenophobia. Look at the, you know, the hate, the racism, the wide divide politically around the world is happening at a time coming off a 10-year economic expansion. The stock market's coming off the highs, and unemployment at the lows. And this is not something you would expect. You'd expect this, what we're seeing right now, to be happening at the bottom of the cycle, not the top of the cycle. So you shudder to think.
But as I digress, the problem here with the infrastructure or fiscal stimulus is, if you're going to-- where are the workers going to come from? Even as bad as things are in Germany, the unemployment rate's at a record low. And the United States is at its lowest level since 1969. I mean, you're going to draw-- what are you going to do, like draw 75-year-olds out of retirement to go build bridges and pave riverbeds and build roads? I mean, so it's nice to talk about infrastructure, but we've sort of run out of skilled tradesmen almost globally. So that's the first thing I'd say.
But in answer to your question, the end game is-- and the end game will be massively reflationary, will be the global debt jubilee. The global debt jubilee, when you get actually the monetary and fiscal authorities working together to print money. And that'll come from the G4 central banks-- the Fed, the ECB, the BOE, and the BOJ. And this is just right out of the Ben Bernanke-- what was Ben Bernanke's moniker? Ben Bernanke, before November 2002, was not called Helicopter Ben.
ED HARRISON: Right.
DAVID ROSENBERG: But he was called Helicopter Ben after November 2002 because the famous What If speech, what if we got caught in this deflationary trap of the zero bond in interest rates. And remember, the Fed went-- and other central banks went as far as they could. Multiple quantitative easings. Who's calling for that back in '07, '08? People thought it was radical enough just take the funds rate towards zero. And look at all of the repeated quantitative easings. But the Fed stopped short of the big bomb. And the big bomb is debt monetization.
And so you're asking me what is it that's going to happen. We're going to eliminate, we're going to have a fire, a bond fire, OK, and we're going to eliminate a lot of this debt through the transaction.
ED HARRISON: The bond fire, I like that.
DAVID ROSENBERG: Yeah, so this is exactly what's going to happen at the end game, is the elimination of the biggest constraint. I mean, there's some things that you can't control. You can't control aging demographics. Or maybe you can, if we have a new baby boom for whatever reason. But that's not going to have any impact on aggregate demand for a couple of decades. What are you going to do with demographics? Not too much.