ED HARRISON: Welcome to Investment Ideas. I'm your host, Ed Harrison, and we are talking to David Rosenberg, chief strategist at Gluskin Sheff. He actually spoke to us three months ago in March and gave us a view that said his investment thesis was long bonds, that is treasuries, and also long on a barbell strategy, defensive dividend paying stocks in equities. So, the question is, is that still his strategy today with the changed environment? Let's take a look.
Welcome back. David Rosenberg, it's very good to talk to you again about investments. I want to talk to you because there's been a lot of changes in the economy since we talked, just to refresh everyone's memory, what you were basically saying is, is that we're going to get a capital expenditure recession, and maybe that was going to lead to actual real economy recession. But at a minimum, you wanted to be somewhat defensive on your equity position, and also go long on the long bonds. The first question I have is, how is that playing out in terms of the whether or not that investment is doing well? And do you still think that that's the way to go?
DAVID ROSENBERG: Well, I almost feel like just maybe hanging up my Hewlett Packard calculator and calling it a day and that's almost like a market hop for me, because those calls have worked out remarkably well. Let's take a look at each one of them. You talked about the capex recession, what was the big surprise in the first quarter GDP? Oh, that great GDP with a three handle that was boosted by lower imports and military spending and soybeans, and lower imports. Real final sales, private sector sales were barely more than 1%.
Well, capital spending negative 1.1. And you're looking at the core capex shipments data so far for the second quarter, negative 1.3. So, the capital spending recession has already started and is joining the housing sector, which has been in a downtrend for the past five quarters. And if you take a look at most of the survey data, for example, they're all showing that capital spending is going to go down for the remainder of the year. And there's going to be knock on effects on the rest of the economy. The consumer right now was hanging on by a thread, still hanging on. But there's lags between one part of GDP getting hit with a negative sign and the impact that has on the rest of the economy.
Then you talked about the markets. Okay, let's look at the stock market. So, we've gone back to a new nominal high, but in reality, the S&P 500 is really back to where it was August of last year. So, 10 months of nothing, the price advances 40 basis points. And of course, I'm picking the time period, but we've been here before the total return really has come down to your dividend.
So, what have been the top performing sectors in the past 10 months or even in the past year? Utilities, telecom, healthcare, real estate, the parts of the stock market you want to own in either in a recession or sluggish growth, lower rate environment. What have been the worst performing sectors? Energy, materials, industrials, and financials. So, there's a real bifurcation here, but it's been the defensive areas of the market that have dramatically outperformed. And then we talked about interest rates.
And I think last time we're on here, I said the next move by the Fed was going to be to cut, not to raise and I said that I love long duration, high quality bonds. And I'm pretty sure that the 10-Year Note Yield is down 60 basis points or so for the last time that we spoke, and it's not over yet. So, the call so far, well, I'm sure you can point out the calls here, you're very gracious. This wasn't rehearsed. But I always appreciate when the interviewer ask me what the calls that I made that were right. I'm grateful to you for that.
ED HARRISON: Well, so far, you are batting 1000. But now, you're updating us on what's going to happen going forward. Would you double down on that particular- especially given the move that we've seen on the Treasury side on the long bond? Or do you think that you might make some shifts there?
DAVID ROSENBERG: Well, let's talk about the bond market, because that's my highest conviction call. And it's not really called the Japanification, you hear that over and over again, and you don't have to go that far out. I call it the UK-nification. Because the question people should be asking is- and we speak the same language. Why is the 10-Year Treasury Note Yield at 2%? Up until a few weeks ago, it was 2.2. Are you saying 2.2, and now, it's 2.0? And that UK's at 80 basis points.
And so, well, here's the answer. The answer is that where does Mark Carney have the cost of overnight funds pinned in the UK is 0.5%. Jay Powell and company, for all the talk of the pivot and the dovishness, they raised rates nine times this cycle. How many of the central banks raise rates nine times in a couple, the quantitative tightening, which by the way, they're still doing at the margin. So, the overnight rate in the United States is two and a quarter, two and a half.
And actually, when you run regressions on the 10-Year Note Yield, and you could do it across a lot of variables, one of the most important explanatory variables is your expectations of where the Fed Funds Rate is going, the overnight cost of funds. Now, it's acted as somewhat as a little constraint, of course, the yield curve is inverted, if you look at from overnight, say to 10 years. But it's act as a constraint in how far the Treasury note can rally. But what I'm going to say is, the Fed is going to go 50 basis points on July 31st.
ED HARRISON: That's a big call.
DAVID ROSENBERG: Well, but it's- okay, let me ask you a question.
ED HARRISON: Because I've heard two people say- at least two other people saying 50 basis points, they're going to do that. They were going to cut big early in order to get us out of it.
DAVID ROSENBERG: Okay. But see, it's interesting. Let me ask you a question. They went 50 in September of 2007. And we'd be talking at that time, and you'd be saying, boy, they went 50. And it was early. Was it early? Or because it was early, how come we had a recession two months later? They went 50 basis points the first meeting, January 3rd. The first rate cut was 50 basis points, January 3rd of 2001. And you would have said, boy, they moved aggressively early. But if it was early, how come the recession started in March of '01, two months later?
So, we're just replaying history here. They've moved 50 basis points as their first move each of the last two cycles. And they'll move 50 basis points and Jay Powell- this is actually handed to us on a silver platter. When you talked about the effect of lower bound, he was asked a question during the Q&A, where he was asked a question about, well, aren't you supposed to be going big with all these rates? And he basically said, what did he say? He said, the ounce of prevention for the pound of cure?
So, 50 basis points I think is- nothing is ever hundred percent sure, but I'd say that's the base case scenario. And not just that, because the markets already got what? The markets got 75 basis points price in for the end of the year. And they've got some more price in for next year. But they're not stopping until they get back down to zero. We're doing a round trip. And then we don't even know how much more aggressive they'll have to get this cycle, there's a lot of risk. And yet, behind closed doors, they're even looking at the prospect of maybe going to negative interest rates.
ED HARRISON: I was thinking that was the next thing, QE, negative interest rates.
DAVID ROSENBERG: Well, hopefully, you'll have me on again in these different intervals. And we're just rewriting chapters of this book, let's take it a step at a time. What I'm saying is that if they go back down to zero on the funds rate, which I think they're going to do at a minimum, the yield curve is going to steepen but the whole thing is going to melt. We're going to have a situation where the 10-Year Note Yield will be converging on where the UK is right now at .8. And most people, especially in the equity market, have no idea how much money you can make being long duration in the bond market.
ED HARRISON: I was telling you off camera before that Gary Shilling came on and his big calls, he's like you want the longest duration you can get, zero coupon bonds. If you actually looked at the bull market in equities from '82 forward, it's five times outperformed the equities. Because that's the longest duration that you can get.
DAVID ROSENBERG: Yeah. And Gary's 100% right. There's no look that those are obviously also risky in the sense if you're wrong on your forecasts, you can get smacked around. But he's not wrong. I'm looking at plain vanilla, 10-Year Treasury Notes. Well, let's take a look at what I said before. I said before that- we were last year 2900 and change on the S&P back in August of 2018, 10 months ago. Total return with the dividend is 2%. Total return in the 10-Year Treasury Note, we'll just take the 10-Year plain vanilla, is 10.5%.
And you can only imagine what the total return will be if we go from here. That was going from say 280 down to two. And now, imagine if you go from two to below one, and the power of convexity at these low levels of interest rates. So, I think the bond market will be a very good place to be. If you go actually to the Commitment of Traders Report, that comes out weekly. And you take a look at the net speculative short position on the 10-Year Treasury Note on the Board of Trade, two weeks ago, that net short position was something like 340,000 contracts net short. This past week, it's gone down to 240,000.
There's people out there that have been shorting the bonds and they're hurting. And so, we're saying the mother of all short covering rallies right now in the Treasury market and it's nowhere close to being over. So, from a frontal perspective, that alone, data aside, the short squeeze in the Treasury market is going to be very significant, yields are going a lot lower irrespective of what's happening to the economy as these shorts run for cover.
ED HARRISON: Now, what about the equity side of that? Because you were talking defensives in particular and dividend players? Do you think that that actually is going to be the play going forward now that we are at new nominal record highs again?
DAVID ROSENBERG: Well, look, I'm not a day trader and I don't call things day to day. But here's what I know. And it's just based on the history of the financial markets. If you go to those periods back in the summer of 1989 and you go to the period of early 2001. And then you go to the last period of say, September of 2007. When the Fed cuts rates, that first rate cut, the market gets a pop. It's a reflexive move to the upside, and it's usually between three and 5%.
So, if you're into chasing dimes in front of the steamroller, well, but there's a dime to be chased. Because in those situations, within the span of about 30 to 45 sessions, you have three to 5%. And everybody gets so exuberant. Remember, the Fed cut the funds rate in mid-September 2007 with 50 basis points and the market popped, and it peaked. It hit the new nominal high back then, October 9th, like about three weeks later. And you knew what's going to happen next, right? But same thing happened in '01 and '02, same thing happened in 1990, '91.
And so, you're going to get initial pop, and you can play that pop. But then you want to get out pretty quickly, because on average, the market rallies three to 5% on the first rate cut. You enjoyed that for 30 to 45 days. And then you're down about 35, 40% to the lows. So long as I'm correct on the recession call, that's how it's going to play out. And this is why Mark Twain famously said that history doesn't necessarily repeat. But it rhymes.
ED HARRISON: Right. But I remember in October, it was Stan O'Neal and Merrill in October, that's when people are like, holy cow, this is where rate cuts are not going to do anything about this whole thing.
DAVID ROSENBERG: With that point, are you talking about October of '08?
ED HARRISON: '07. Because it was when Stan O'Neal said, by the way, we're going to write down massive amounts. That was in '07?
DAVID ROSENBERG: That was in '07.
ED HARRISON: Yeah. So, October '07, that's when they were like these rate cuts, it's not going to happen. It's not going to get us there. Now, let me let me ask you about the capex thing, because I think that's interesting that you were talking about business sentiment, and the real question is whether or not these capex cuts are going to stabilize or accelerate, because some of the data that I've seen are horrific. For instance, the Morgan Stanley Business Confidence Index was down the most ever from month to month recently. And it's at this lowest point since the last recession, first of all is, do you think that this is going to stabilize or it's going to accelerate? And then the second thing is, are we actually in a recession right now?
DAVID ROSENBERG: Are we in recession right now? Let's tackle that. Well, that's an interesting question. And it's difficult to answer. I think that there's a case that can be made. I know that Gary has made that case, I'm very sensitive to it. People will say, well, will GDP, which is the overall economy had a three handle in Q1, Atlanta Fed is up to 2% for Q2, how could there be a recession? But you see, the recession and expansion is defined by one body, called the National Bureau of Economic Research, a tip of the hat to Martin Feldstein who just passed away who headed up that organization. They are the arbiters of the recession. And usually, tell us the recession ended or began a year after and also, it's a bit of a lag, but it's very meticulous.
Guess what? GDP is not part of the calculation, just so happens that GDP is very weak, and a recession usually does go down. If you actually go back to that last say capex-led recession in '01, really was March to November of '01, GDP hardly budged.
ED HARRISON: And I think it went up one up, one down and one up in 1990, '91.
DAVID ROSENBERG: Right. So, you can't just look at GDP, don't forget GDP has got the government sector in there. So, there's the four basic tenets of the recession or what defines the contras of the business cycle- are these four things, okay? Real business sales, that's trade manufacturing, industrial production, employment, and real personal organic income or income in real terms, net of government transfers. Three of those four have already peaked for the cycle.
Now, you'll say, well, employment. Well, employment. The problem at turning points is that the payroll survey is a lagging indicator of turning points because the payroll survey still has an estimate in there of new business creation, the birth-death model, that's accounting for like half of the employment growth, the payroll number, which everybody trades off of, at this point is a misleading indicator because it's not just based on the sample of companies that are being surveyed, but also, the estimate of new jobs being created by new businesses.
Well, guess what? I looked at the data and that new business creation in the United States is stalled. And that's why the payroll survey is actually very poor indicator. 90% of the time, it is the better indicator of the two surveys except the turning points, heading into an expansion, heading into a recession. It actually gave you a false signal back in 2007. People tend to forget that.
ED HARRISON: Revisions, however, like for instance, the fact that the revisions are now starting to be negative, is that potentially a sign that we're getting into a turn?
DAVID ROSENBERG: That's another very- so, what you call a very procyclical development. So, I think that's part of it, too. But I looked at the work week, like I'm looking at, for example, the Index of Aggregate Hours Worked for production, nonsupervisory workers peaked back at the beginning of the year, that's total labor input. So, that's already peaked.
But I think the household survey does a much better job at turning points. And the household survey is down about 200,000 this year, it's contracted. The last time household employment was down in the first five months of the year as it has this year was back in 2009. And the year before that, was in 2008. So, the question is, what survey are you looking at? Employment has peaked. And we know industrial production peaked in December of last year, industrial production is down 1.5% in the annual rate in the first five months of the year, notwithstanding the little noisy pickup that we saw in May. And real organic income growth, real organic income actually also peaked in