“I’ve been in the deflation camp for two decades,” says Gluskin Sheff’s David Rosenberg. But now “it is time to move on”.
Rosenberg was among the first to warn that America was heading for a recession, and that the recovery from the credit bust would be unusually slow and prone to reversals as America had a huge debt load to work off. Given this discouraging backdrop, he was worried that the gradual decline in inflation since the early 1980s could become outright deflation. So he has been a bond bull in recent years.
But now he reckons that the turning point for the bond bull market, which began in the early 1980s, has arrived. It came last year when Treasury yields reached their historic lows and then began to rise. “A secular bear market” in bonds is in its infancy.
So why has he changed his outlook? For starters, reckons Rosenberg, “there is evidence that the consumer deleveraging cycle is largely over”. Subprime auto credit is up by an annual 30%, while 20% of mortgages are now being written with down-payments of less than 10%. Consumers account for 70% of the economy, so if they are now in a position to spend more, the outlook for demand is improving.
Meanwhile, there is less spare capacity in the economy than commonly assumed. A great deal of capacity has been taken out of the labour market: nine million people have dropped out of it since mid-2009, and only three million jobs have been added since then. The problem seems to be that workers can’t provide the skills employers are looking for.
In any case, “less competition for available jobs” implies rising wages. The US economy is only likely to be able to grow by 1.7% a year without generating inflation. Inflation is on the way and long-term interest rates will move higher. Investors should start hedging their portfolios against this prospect now.