-->Is history destined to repeat 2002?
Still in 'post-bubble convalescence,' says Merrill economics star

William Hanley
Financial Post


Saturday, December 14, 2002

CREDIT: Glenn Lowson, National Post

David Rosenberg says he is convinced we are not in a new bull market.


David Rosenberg laughs about his choice of Nami - a popular Japanese restaurant a few blocks from Bay Street - for our lunch on Thursday. Recently elevated to the lofty position of North American chief economist at Merrill Lynch, he says he selected Nami because he's going to be spending more time south of the border and there are worries that the United States may be following Japan down the road to a secular bear market in stocks, to economic stagnation and to deflation.

As it happens, we've been checking the Nami menu before Rosenberg arrived and can find little evidence of deflation -- the prices of the broad choice of sushi, sashimi and other Japanese fare are either where they were or a little higher than when we last dined here about a year ago. But Lunch Money does appreciate any help in constructing a convenient bridge from lunch to money, so we toast his great new job with a couple of stiff Perriers while he orders an array of sushi and we stick to a combo of salmon teriyaki and shrimp and vegetable tempura.

And as it happens, Rosenberg, promoted amid much fanfare the previous week from his position as Merrill's chief Canadian economist and strategist, believes there are deflationary similarities between the two countries, including the Nasdaq bubble bursting like the Nikkei's and the accompanying wave of corporate malfeasance."But Japan's bubble went beyond just the equity market," he says."The critical difference is that in the U.S., you have political accountability. In Japan, the old guard continues to call the shots."

Rosenberg, who lives just north of Toronto, has just flown up from New York, where he'll now be spending about half his working week, and he's still excited about his new position at the world's biggest investment dealer, where he'll call the shots on the North American economy and work closely with equity strategist Richard Bernstein.

"My role is to make the economics relevant and blend it into the strategy" -- a task he performed so well in Toronto, where his more downbeat views stood clients in good stead.

As 2002 comes to a merciful end in the markets, the economic data are telling Rosenberg the consensus analysts' earnings projections for 2003 that are supporting current stock prices will almost certainly turn out to be too high, that the market is likely destined to struggle again next year.

"There's almost perfect symmetry. Exactly a year ago today, the market was pricing in almost 15% earnings growth for 2002 (which never materialized). Now the market is calling for roughly 13% earnings growth for 2003. We're going to have to rewind the tape and play it all over again. It's not that earnings aren't turning. The question is are earnings going to turn fast enough to justify the valuations."

His answer is no, unless there are some positive surprises he just can't envisage in what he calls this post-bubble convalescence."We'll probably end up with an earnings growth rate of close to high single digits rather than around 13%," he says, deftly using his digits to chopstick hot wasabe on to his sushi.

Meantime, Rosenberg says the consensus estimate of 40% corporate earnings growth for the Canadian stock market is even more out of line. And that's why our market looks a lot cheaper than its American counterpart.

"Canada's analysts are far more ebullient than those in the U.S. You'd need nothing short of a sharp, synchronized global expansion to justify the near 40% earnings expectations that are priced into the Canadian equity market right now. Those earnings numbers have to come down."

Nevertheless, there will continue to be sporadic technical rallies like the recent one and the other bear market ones that preceded it. But, time and again, they'll be interrupted by the market's major story -- earnings disappointments.

"If I am convinced of one thing," Rosenberg declares,"it is that we are not in a bull market. We either break below the October lows or meander and it's going to be a stock market much like the past year -- sloppy and choppy, with heightened volatility making for a stock-picker's dream and a long-term investor's nightmare."

But the way this post-bubble convalescence is playing out, some equity sectors will outperform.

Rosenberg believes that corporate spending -- mainly responsible for the economic and stock market downturn -- is beginning to recover and that company balance sheets are now in better shape than those of the debt-defying American consumer.

That tells him the capital goods sector stocks, excluding technology, will do better sooner than the consumer discretionary issues.

And if there's another theme playing out in the post-bubble convalescence, it's income, which makes great sense in a low-return, low-inflation world and which accounts for the growing investor interest in the corporate bond market, income trusts and dividend funds.

Even though the corporate sector is in better shape than it was a year or two ago, it will still ultimately be up to the consumer to begin spending again. But that will take time as the consumer repairs the household balance sheet by increasing the savings rate.

"There will be no double dip in the economy," Rosenberg says as the crowd at Nami thins out and the reasonable but non-deflationary bill arrives for a good meal efficiently served."But be prepared for the slow-motion recovery -- round two."

Next year's U.S. gross domestic product growth in this so-far jobless recovery will be roughly the same as this year's 2.5%. But deflation tops the list of his concerns --"If you don't see deflation risks, my advice is to go see an optometrist."

That's not his only worry. The strong housing market that has propped up the U.S. consumer's spending is showing signs of fatigue and the U.S. dollar, which has stayed relatively strong, could come under greater pressure that would be felt in stock and bond markets.

Throw in the likelihood of a war on Iraq and there's lots to concern Merrill's new chief North American economist.

whanley@nationalpost.com