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David Rosenberg

In a weak economy, bonds and bullion shine brightest Add to ...

The U.S. stock market turned in a surprisingly vigorous rally in the past few months, but it would be a mistake to attribute this to any real improvement in the economy.

A double-dip recession has been avoided for now, but there is little to indicate that the economy is strengthening. The markets began to climb in late August, not because of better data, but because of comments from Federal Reserve chairman Ben Bernanke that another round of quantitative easing was coming our way.

The rally ended, not on any particular piece of economic data, but right after the Federal Open Market Committee meeting a few weeks ago, when it became clear that the central bank was seriously split on the notion of further quantitative easing. It was a classic case of buying the rumour and then selling the fact.

For all the talk of an improving economy, the number of data points that were positive since the market bottomed in late August has been roughly equal to the number of negative data points.

I can understand the preoccupation with non-farm payrolls, but the bloom comes off the rose when one turns to the Household Survey of the jobs situation and sees that full-time employment has declined now for five months in a row.

Industrial production has not budged one iota since July. Meanwhile, housing starts collapsed 11.7 per cent in October after a dismal 4.2-per-cent decline the month before.

The upward revision to third-quarter GDP was impressive, showing an increase to 2.5 per cent at an annual rate from 2 per cent initially, but the monthly data reveal a sharp deceleration. Over the three months to September, real GDP growth actually slowed to a 1-per-cent annual rate.

Based on information at hand, it looks as though fourth-quarter real GDP growth is coming in closer to a 1.7-per-cent annual rate, so the moderation in overall economic activity will be more evident this quarter than it was in the third quarter.


Heading into the second year of a recovery, Mr. Market expects to see 5-per-cent growth; not an economy trudging ahead under 2-per-cent growth and rife with downside risks.

To be sure, corporate profits have been terrific, but not because of any meaningful increase in top-line pricing power. Fully 96 per cent of the rebound in output since the recession ended has been due to productivity growth.

Increased productivity leads to income growth, but that income accrues to capital, not labour, where there continues to be dramatic excess capacity in the jobs market. The broadest measure of the unemployment rate - the so-called U6 rate, which includes people who are working part-time because they cannot find full-time employment - is 17 per cent.

Compensation per hour is declining and unit labour costs have fallen nearly 2 per cent in the past year. Falling employment costs have provided a major underpinning for profit margins. How long the productivity miracle can last is anyone's guess, but the excess slack in the labour market will linger on.

What kept the U.S. consumer alive through all this was massive help from Uncle Sam, but that is now likely coming to an end, which in turn will hurt domestic demand and revenue growth for the business sector. So, the combination of strong growth outside the United States and sustained productivity gains are going to be needed more than ever for profits to continue surpassing expectations into 2011.

The bottom line is that for the past year, the S&P 500 has crossed above the 1,200 mark five times and has moved below the 1,100 threshold no fewer than 13 times. For over a year, the market has been moving sideways between roughly 1,000 and 1,200.

Year to date, the total return on U.S. stocks has been a bit better than 8 per cent. That is well short of the 12 per cent achieved by the long Treasury bond and the 10-year Treasury note and 10 per cent by the corporate bond market. Gold is up nearly 30 per cent and silver by more than 60 per cent. The strategy I've been espousing for years, of buying both bonds and bullion, worked again in 2010.

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