David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.
Next month marks my 30th anniversary as a Street economist – from Bay Street to Wall Street and then back to Bay Street. In fact, the exact date of my first day as the financial markets economist at the Bank of Nova Scotia was Oct. 19, 1987, otherwise known as Black Monday. That actually turned out to be a great day to start a career despite all the nail biting. It taught me the difference between a correction and a bear market – what separates them is not magnitude as much as duration. The time you spend in the contraction and the time it takes to recoup the lost capital. What happened in the Fall of 1987 was a steep correction, not a bear market, though that was a tough sell back then during the eye of the storm.
Indeed, the next fundamental bear market did not take place for another three years. And what caused that bear market was a recession – something that was averted in 1987, which in retrospect was a liquidity event. When we confronted the 1990-91 bear market condition, a recession was at hand and that leads to another critical point – that bear markets only occur when there is outright contraction in economic activity.
It is a comment on human nature that in the Fall of 1987, many pundits believed the equity-market devastation would lead to recession. When it became apparent by the Winter of 1988 that the expansion was intact, the mood swung massively bullish and the consensus swung to a view that the Reagan upward trend would never end. Well, it did, just after celebrating its 92nd month.
This current cycle also deserves a toast because it turns 100 months old in October. What a milestone. If it lasts to May, it will be the second-longest since the U.S. Civil War (only that superlong cycle of the tech-led nineties will have been longer). I have more to say on this below, but I want to point out that while expansions and bull markets don't ever just die of old age, they usually come to an end at the hands of the Fed. It will not be any different this time around.
After 30 years of experience as a Street economist, you pick up a lot of learning lessons – especially from the mistakes made along the way. Here are my top five below:
- Don’t put all your eggs in one basket (concentrated portfolios but diversified geographically and across the asset classes);
- There is no such thing as a sure thing (the forecast is just a base case across a continuum of possibilities across a distribution curve);
- Marry your partner, not your forecast – it may not love you back (what gets economists into trouble is lack of humility; admitting you’re wrong is never easy);
- If you don’t have a Plan B, you don’t have a plan. If you are wrong, it is imperative to know in what direction – and delineate the new course of action;
- Anything that can’t last forever, won’t last forever.
And it is with that fifth lesson in mind that I emphasize again this economic cycle turns 100 months old in October. I'm not saying it is the bottom of the 9th yet, but it's not the national anthem either and very likely past the 7th inning stretch.
Our in-house research, based on capacity, economic and market variables, shows that we are 90 per cent done in terms of the economic cycle in the United States and Canada, which means 2018 will be the last year of expansion, in all likelihood. This does not mean head for the hills or raise cash as much as mold the portfolio into something that works more often than not late in the cycle, which is the opposite to how you would treat it in the early innings. The level of risk is just completely different and has to be priced as such. And so it means an extra focus on quality, balance sheet strength, liquidity, reducing the cyclicality of the portfolio, and having more exposure to companies that have no correlation to GDP and have low earnings volatility and high earnings visibility.
Or, there is a companion strategy of moving funds to parts of the world that are more mid-cycle, with a longer runway for growth, friendlier central banks and superior valuation metrics – on both sides of the ocean. The euro zone expansion is 53 months old, so call it the 4th inning if North America is 8th; Japan's is 36 months old and the country is now undergoing a tremendous positive shift toward unleashing an equity culture, one reminiscent of the United States back in 1982 when price-to-earnings multiples were single digits. When we run the same numbers for Japan, the euro zone and emerging markets, we see that they are anywhere from the 4th to 6th innings in their cyclical phase.
Remember that Canada is 3 per cent of the world market cap, the United States is another 33 per cent, so there is nearly 65 per cent of the world's equity-market cap, or around $50-trillion, well worth a look at right now across both oceans. And we've been doing more than just looking – we have more than $800-million of exposure to this part of the world and are continuing to focus on boosting that exposure. Go east, young man, or go west, but avoid the classic syndrome of "home bias" if you live in North America.
David Rosenberg