During 1997-98, when the US stock market had exceeded all prior valuations and all historical signs of warnings were being ignored, it was clear to me that a new mood of carelessness had taken root among the America's "educated" class; there was a widespread lack of cautious attitude; and an unhealthy lack of skepticism existed about the promoters and business leaders, including the Federal Reserve. I concluded then that whenever this ends, and it has definitely not ended yet, it would end badly. At the time I shared an insight with a colleague at Cisco stating that the worst will not come until those who are cautious and issuing warnings either capitulate or are discredited, primarily because of the length of time during which they have maintained their negativity about the future. All this is part of human nature. The past ten years, especially, in the US, have been a period of extraordinary speculation among the middle class, first in stocks and later in housing, the two largest asset classes. All indications are that speculation in housing is coming to an end, very rapidly.
It appears that we are now at a point in time when the worst that some of us doom-and-gloomers have been predicting might be near. The reason for this assessment is that something very important transpired during the past few weeks that has gone mostly un-noticed - four noted pundits, two economists and two investment gurus, employed by the most powerful and influential financial firms in America, who were cautious for a long time, capitulated.
Two of them, Rich Bernstein and David Rosenberg, work for one firm, Merrill Lynch, and their capitulation could be taken as a result of a common conclusion. The other two, Stephen Roach of Morgan Stanley and Bill Gross of PIMCO, have given up their bearish outlook for the US and the world economy.
All this happened over a period of 15-20 days during which the financial markets seem to be signaling greater danger and uncertainty ahead than for quite some time.
It all began with David Rosenberg, being interviewed remotely on CNBC, said, "We have raised our target on S&P 500," i.e., he and the firm have turned more bullish on the stock market. Mr. Rosenberg, the Chief North American Economist for Merrill Lynch, has been very cautious on the economy, big believer in the Housing Bubble and its recent burst, and is a deflationist, i.e., the economic forces in play are deflationary and inflation is not a threat. Only a few days ago I received an e-mail from a fellow bear and deflationist with the title, "Excellent report from Merrill's David Rosenberg, with a deflationary theme." I had read that report and hundreds of other reports from Mr. Rosenberg for the past 2-3 years and I have examined thousands of graphs and tables complied by his team. Most of them support a negative view of the US economy going forward and a deflationary bias, as the Housing Bubble's support of the economy unwinds and the general demand goes down.
Almost at the same time Mr. Roach, the most famous bear on the US economy, threw in his towel with, "World [suffering from growing US-led imbalances for years] on the Mend," where he states: "While an unbalanced world has yet to shake its hangover from global healing, I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages." The most interesting part of this newfound enthusiasm is his admission at the very beginning that the last time he felt this good, about "global healing," was in 1999 and he was proven wrong instantly! It appears that Mr. Roach is none the wiser in seven years. Is the recent run up in gold price a signal of "global healing" or the "global imbalances" blowing up, as Mr. Roach has feared for years?
An soon as the news of Merrill Lynch's top economist and top strategist turning bullish on the stock market reached CNBC, Rich Bernstein was invited to its "world headquarters" on the morning of May 3rd and was welcomed with open arms. Essentially, the team at Merrill Lynch, which had the most bearish allocation among the leading firms, had cut its allocation of bonds and simultaneously increased its allocation of stocks, i.e., and had turned bullish after a 15% relative out-performance of stocks over bonds over a 6-7 month period! Thus far, it is turning out to be a very bad move.
Those with whom I communicate frequently know that I have held the two gents from ML in the highest regard for their excellent analyses. It is obvious that those employed by Wall Street firms have pressures to be bullish and one has to be very good if he is bearish, or cautious, for a long period of time. Bernstein and Rosenberg were undaunted in their cautious views because of the supporting data that they could provide. So, when I heard the change of view I smelled something fishy because their analyses had hardly changed.
If anything, Mr. Rosenberg's recent analyses are more supportive of a weakening US economy and deflationary pressures.
The reason, a lame excuse, in my opinion, that Bernstein gave for the changes in allocation is that the ML team sees lower dollar. If one examines the relationship between the dollar and US stocks and bonds, over the past ten years or so, one would come to an opposite conclusion. Second, the weakening US economy, one impetus for lower dollar, can't be good for stocks and bad for bonds. If there is a pressure on someone to change his bearishness I am sure a reason can be concocted.
The last one to capitulate, and the most influential financial guru in the US in recent years, is Bill Gross. Just last week he changed his forecast for the 10-year US Treasury Note yield range from 3.0-4.5% to 4.0-5.5%. This after the rate had touched 5.2% and has been above 4.5 for more than three months. What was Mr. Gross's excuse? He is now more bullish on the outlook for the world economy. What has changed over the last few months to give that outlook? When the two biggest voices among bond bulls, Gross and Rosenberg, throw in the towel for rates to go below 4% who is left? A yield below 4.0% is very likely in 2006 now that Mr. Gross has given up on it. Had the "Bond King" called the top in the bond yields? The Bond Prince thinks so.
The only people left among the bears are the underground ones, those who have a very limited circulation, or audience, thanks to the Internet. Even they have suffered some credibility loss because people are impatient and demand an outcome in a short period. Those of us who focus on the long cycles know how long it takes for the imbalances to build up and it could take years before they are resolved. Let me quote Greenspan: "Knowing that something will happen and when it will happen are two different forecasts. The latter is harder than the former."
From the conditions that have existed in the US for the past ten years, Greater Depression is unavoidable; the only question is: when? I think that the time-window has been narrowed down to this decade. It is dependent on how the consumption debt plays out. The man who contributed to the dangerous condition of the household consumption debt in the US ignored his own advice, "Debt is bad. Pay it down as fast as you can." Also, he shared my distinction of the private debt for consumption versus for productive investments, "...there is no limit to the size of private debt, provided it is used for productive purposes."
I believe that the capitulation of the four noted pundits, over a very short time frame, can be taken as a signal of something big to begin in the coming months and quarters. If my prediction of the next recession to begin in 2006 were to come true it would be preceded by a significant drop in the stock market before the end of August. Who knows, it could have already started.
Another important signpost would be when TOL, a high-end Hopebuilder, falls below $20. When it falls to $15, we might have entered the recession already or only a month or two away (the economists only inform us 6-9 months after the beginning). If the recession does begin in 2006, it is a safe bet that the world would be in a deep depression by 2008. Busts follow booms as surely as the sunrise is followed by the sunset.
PS: I just heard someone on the phone on CSPAN2, who sounded like a regular white guy, say, "I grew up loving America and I hate America now ... it is horrible." He was calling in with comment on the economy and distribution of incomes. Something has happened over the past year or two to the American psyche in terms of how they perceive the economic conditions that is not captured in the economic statistics. I believe that it has a lot to do with burdening the middle-class with humongous amount of debt that Mr. Greenspan thought is a very bad idea for a person, or a household, to have.