Hold on to your hats. It may be time to turn your U.S. portfolio on its head.
That's because there's growing evidence that the U.S. economic cycle is more advanced than is generally recognized — and that there is a higher risk that the economy could be in for a hard landing, not a soft one.
This is the view of David Rosenberg, North American economist for investment dealer Merrill Lynch & Co. Inc. in New York.
“Practically every indicator at our disposal tells us that we are very late cycle, and the historical record also suggests that the next wave after the Fed has inverted the entire yield curve is either a hard landing or a very bumpy soft landing,” Mr. Rosenberg said in a commentary, referring to the U.S. Federal Reserve Board's interest rate policies. “Either way, the economy is going to have some sort of a ‘landing,' which is far different than a ‘takeoff.'”
Noting that the U.S. economy enjoyed a good “takeoff” in 2003-04, he added that he “would highly recommend that investors switch their portfolios to a complete inverse of what worked and didn't work at that earlier stage of the cycle.”
Economic models run by Merrill Lynch suggest the odds of the economy enduring a hard landing range from 40 to 80 per cent, well above the consensus view, which pegs them at just 27 per cent, Mr. Rosenberg said.
In a decision Aug. 8, the U.S. Fed left its benchmark federal funds rate unchanged at 5.25 per cent, following 17 consecutive hikes dating back to June, 2004. The rationale was that slowing economic growth will curb inflation.
A key element of the slowdown on which the Fed is banking, as it seeks to guide the U.S. economy to a soft landing, is an orderly turndown in the U.S. real estate market, where a housing boom has been a major driver of growth.
However, Mr. Rosenberg argued that a two-year low in housing starts reported last week, along with the first downturn in 15 years in the number of building permits issued and a record six-month decline in the National Association of Home Builders housing market index, means the slowdown is much more precipitous than the U.S. central bank wanted to see. “The real estate turndown is proving to be a tad less ‘orderly' than policy makers were hoping for,” he said.
In fact, Mr. Rosenberg cited a speech delivered last Wednesday by Dallas Federal Reserve Board president Richard Fisher, who, quoting what someone he called a friend and a major home builder had told him, said: “This is the roughest, most sudden correction we have seen in the housing market.”
The Merrill Lynch economist argues that the housing “recession” will last at least four more quarters and, through direct and indirect impacts, carve almost two percentage points of U.S. economic growth. “That may not be enough to generate an overall recession ... but seeing as such a pace of activity would take the unemployment rate back to over 5½ per cent, it sure would feel like a recession for a whole lot of folks,” he said.
The universe does not look quite so bleak to Tobias Levkovich, chief U.S. equity strategist at Citigroup Inc. in New York.
He noted Monday that although stocks in the utilities and telecommunications sectors tend to underperform following a plunge in the housing market index, those in the financial and consumer staples sectors tend to outperform.
“While it may be somewhat obvious that people still need to buy food and sundries and would defer more extravagant expenditures in the midst of a housing slowdown, it is encouraging that the stocks indeed trade the same way,” Mr. Levkovich said. “In contrast, consumer discretionary stocks can be hammered when things sour in the housing market.”
