Three Economic Bears Seek Goldilocks Economy in U.S.
When it comes to the U.S. economy, the glass may not be half empty after all.
Three prominent bears -- David Rosenberg, chief economist at Gluskin Sheff & Associates, Mohamed El-Erian, chief executive officer at Pacific Investment Management Co., and David Levy, chairman of the Jerome Levy Forecasting Center -- separately see some hopeful signs. These include a housing market that is healing, a more competitive manufacturing industry and technological breakthroughs that could boost productivity.
“More so than at any time in the past three years, I’m doing whatever I can to identify silver linings in the clouds,” Rosenberg said.
None of the three is ready to declare the all-clear. While the chances the economy could perform better than expected are “somewhat” higher than before, the downside risks are bigger, said El-Erian, who oversees $1.9 trillion at Pimco in Newport Beach, California. These include the so-called fiscal cliff, which all three agree would trigger a recession if nothing is done to avert its spending cuts and tax increases.
The continued caution of the three economists is reflected in advice they are giving investors. Rosenberg recommends gold- mining stocks and shares of utility companies, the latter as part of a strategy he’s dubbed “Safety and Income at a Reasonable Price.”
“This is a time to be defensive,” said Levy of the Mount Kisco, New York-based economic forecaster. “We are still in a rocky period.” He has been bullish on Treasury bonds for more than five years and eventually sees yields falling even further. The yield on the 30-year bond was 2.78 percent as of 5 p.m. yesterday in New York, according to Bloomberg Bond Trader data.
El-Erian suggests investors look outside the U.S. for economies that are growing faster and put money in companies and nations with strong balance sheets, including Brazil’s and Mexico’s local bonds. He said investors also should “actively” manage their portfolios to protect against downside risks and take advantage of upside surprises that might materialize through the use of puts, calls and other trading strategies.
El-Erian and Rosenberg recommended a defensive stance on financial markets about a year ago in separate interviews on Bloomberg Television. Toronto-based Rosenberg said investors should look at dividend-paying health-care, utility and consumer-staples stocks, which are least-tied to changes in economic growth.
Drugmakers in the Standard & Poor’s 500 Index are up 16 percent and producers of household goods have risen 9.7 percent in 2012. Utilities have fallen about 2 percent for the worst performance among the 10 major industries in the gauge.
El-Erian said Dec. 19 that the first part of 2012 would be “risk off” as Europe’s sovereign-debt crisis encouraged demand for safety. Yields on 10-year U.S. Treasuries rose to 2.21 percent on March 30 from 1.88 percent at the start of the year, while the Standard & Poor’s 500 Index (SPXL1) jumped 12 percent. For the year to date, the stock index also is up 12 percent.
The U.S. economy will grow 2 percent next year and 2.8 percent in 2014, the Paris-based Organization for Economic Cooperation and Development said last month. That is faster than the average for the OECD’s 34 members of 1.4 percent in 2013 and 2.3 percent in 2014.
Both Rosenberg and Levy foresaw the bursting of the housing bubble in 2007, the former when he was chief economist for North America at Merrill Lynch & Co. in New York. They’ve generally been more pessimistic than the consensus of economists since then, with Levy saying the U.S. is experiencing a “contained depression,” and Rosenberg incorrectly forecasting the U.S. would relapse into recession at the start of this year. The previous slump began in December 2007 and lasted 18 months.
El-Erian and his colleagues at Pimco also have tended to be more downbeat. The 54-year-old former International Monetary Fund economist first used the term “new normal” in May 2009 to describe the probable medium-term path of the global economy. For the U.S., that meant annual growth of about 2 percent.
Since the recovery began in the middle of 2009, GDP has expanded by an average of 2.2 percent, in line with the Pimco forecast and short of repeated projections for faster growth by the Federal Reserve and the White House.
Pimco’s Total Return Fund, the world’s largest mutual fund, is up 10.3 percent this year, beating 95 percent of similarly run mutual funds, according to data compiled by Bloomberg.
It has attracted about $17 billion in net new money in 2012, according to Chicago-based research firm Morningstar Inc., after losing $5 billion to withdrawals in 2011, when it suffered what William Gross, the company’s co-chief investment officer with El-Erian, called “a stinker.” It eliminated U.S. Treasuries early in the year and missed a rally when investors rushed to the safety of government-backed debt.
One reason Rosenberg, 52, is trying to look on the bright side is because many other economists have turned more bearish.
“That’s raised my contrarian antenna,” he said.
GDP probably will grow 2 percent in 2013, down from a projected 2.2 percent this year, according to the median forecast of 74 economists surveyed by Bloomberg last month.
Among the more hopeful signs, Rosenberg said, is the bottoming out of the housing market. New-home construction rose 3.6 percent to a four-year high in October, according to the Commerce Department.
“We’re in a strong phase of the recovery,” Martin Connor, chief financial officer of Toll Brothers Inc. (TOL), a Horsham, Pennsylvania-based luxury homebuilder, said during a conference presentation on Nov. 15. “It’s a function of five years of pent-up demand being released.” Affordability and rising prices also are “spurring people to buy.”
The banking industry also is on the mend, Rosenberg said. “The banks are certainly in better position and more willing to lend money than they have been for years,” after buttressing their balance sheets.
JPMorgan Chase & Co., the biggest U.S. bank by assets, provided $15 billion of credit for small businesses in the third quarter, up 21 percent from a year earlier, Chief Executive Officer Jamie Dimon said in an Oct. 12 press release.
Rosenberg also is encouraged by what he calls a “secular renaissance” of the U.S. manufacturing industry -- with output rising 16 percent during the recovery, according to the Fed -- and a surge in American energy production.
U.S. oil output is poised to surpass Saudi Arabia’s in the next decade, making the world’s largest fuel consumer almost self-reliant and putting it on track to become a net exporter, the International Energy Agency said last month.
Even so, problems remain. Rosenberg said he is particularly worried about continued high unemployment -- 7.9 percent in October, up from 4.7 percent five years ago -- and its impact on worker earnings.
“This will go down as a wageless recovery,” the Canadian economist said.
Average hourly earnings for production workers rose 1.1 percent in the 12 months to October, the weakest since Labor Department records began in 1965.
The bottom line for Rosenberg: The economy still is “stuck in the mud.”
Pimco’s El-Erian predicts GDP probably will grow 1.5 percent to 2 percent during the next year as President Barack Obama and Congress strike a “mini-bargain” to avoid the fiscal cliff and moderately reduce the budget deficit.
The economy could do better if policy makers can pull off what El-Erian calls a “Sputnik moment” -- a critical mass of reforms that restores corporate confidence and unleashes pent-up investment, hiring and demand. Such steps might include measures to tackle youth and long-term unemployment, as well as cutting the deficit.
“There’s tremendous cash on the sidelines,” he said.
David Cote, chief executive officer of Morris Township, New Jersey-based Honeywell International Inc. (HON), says a budget deal alone could do wonders for the U.S.
“There is a prospect for a robust recovery, something bigger than I think most economists are forecasting,” if the White House and Congress can reach a credible agreement to reduce the deficit by $4 trillion over 10 years, he told Bloomberg Television on Nov. 28.
El-Erian, who re-joined Pimco in 2007 after being in charge of managing Harvard University’s endowment, also sees a chance that technological breakthroughs could give the U.S. a productivity-driven boost. At the top of the list is digitalization: the conversion of pictures, sound and other information into a form computers can process.
“The whole trend is having an impact on very many sectors of the economy,” he said.
The trouble is that while the potential for such pleasant surprises is bigger than before, it isn’t “meaningfully” bigger, according to El-Erian. And the downside dangers are greater, he said. Besides the fiscal cliff, they include the debt crisis in Europe, China’s challenge in overhauling its export-driven economy and the risk of continued instability in the Middle East.
Levy said the U.S. private sector is in the middle of a prolonged period of cleaning up its balance sheet after decades in which debt grew faster than income.
“We’ve been at this for five years,” he said. “If we’re lucky, it might take a tiny bit less than a decade.” He added he’d be surprised if the U.S. is able to avoid a recession in the next few years.
America, though, has made more progress than Europe and Japan in dealing with its debts, Levy said.
“The U.S. will do generally better in this rocky period than much of the rest of the world, because the risks are higher and the problems are bigger in many places overseas,” the 57- year-old economist said. That includes China, where new leaders face decisions on how -- and whether -- to curb state enterprises, boost access to credit for private companies and raise consumption.
Levy, who served on the board of the Levy Economics Institute of Bard College in Annandale-on-Hudson, New York, from 1986 to 2001, said America also will benefit from a “secular improvement” in its trade balance. Driving that improvement: the manufacturing revival, boom in domestic energy output and increased demand for U.S. agricultural exports as developing nations grow richer.
“By the end of this decade, we might be looking at trade surpluses,” he said. The U.S. ran a $415.5 billion trade deficit through the first nine months of this year.
Future business investment also is being stored up as companies put off capital expenditures because of depressed demand for their products, he said. Eventually, such spending will surge, boosting productivity and profits.
“While the U.S. is going through a long-term, rough adjustment period,” Levy told Bloomberg Radio Nov. 13, “we are weathering it.
‘‘We are going to come out the other side,’’ he added. ‘‘And there is a very bright long-term.’’