What Is the Best Way to Design an Investment Portfolio in a Turbulent Environment?

Interview with David Rosenberg

David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates, and has also written a book titled, Breakfast with Dave, a daily distillation of economic and financial market insights. In this interview, he talks about designing the right investment portfolio.

Douglas Goldstein: I am very excited to have on, The Goldstein on Gelt Show, David Rosenberg, who is the chief economist and strategist for Gluskin Sheff + Associates, a Canadian-based firm that manages portfolios for investors, professionals, and family trusts.

As an economist, he is in a great position to talk to us about designing a portfolio that makes sense, given what seems to be a rather turbulent, political environment.

David, does politics really matter for people who are long-term investors?

Politics Drives Investor Sentiment

David Rosenberg: I don’t think that politics is going to have a large influence, if you have a time horizon that’s beyond three or five years. It can produce ripples along the way and short-term fluctuations, but ultimately, investors must keep both eyes firmly on the economic fundamentals, because they will eventually win every single time if you have a long enough time horizon.

This is true whether you’re investing in commodities, or in currencies, or in the bond and stock markets.

Douglas Goldstein: When the politicians speak, people react like, “Oh my Gosh! Health care is going to collapse. There’s going to be a war in the Far East!” and these seem like fundamental changes.

However, for people who have been around long enough, we realize that this sounds like a broken record because there’s always something major going on.

How do you distinguish what’s a fundamental change and what’s just a lot of noise?

Establish the Economic Fundamentals

David Rosenberg: First, I will give the best example that’s on our minds right now, which is Trumpenomics and the notion that a Donald Trump presidency with a one-party rule in The House and the Senate would mean we embark on a prolonged period, in an era of sustainable, accelerating, economic growth and inflation. That was the narrative that started on November 8th.

Then, of course, we have the reality, which is that the economy is not doing any better than it was when Barack Obama was president and, if anything, underlying inflation pressures are dissipating.

I know people will say, “Well, look at what the stock market is doing.” The parts of the stock market that are doing well are technology stocks, which are operating on their own set of dynamics.

Yet that was the one part of the stock market that was supposed to do the worst under a Trump presidency, because technology is the most hitched to global supply chains, which were expected to break down with the xenophobia, isolationism, and nationalism that was supposed to follow this Trump presidency.

That hasn’t happened.

Trumpenomics Has Not Changed the Fundamentals

David Rosenberg: The truth is always in the bond market, and you have 10-Year Treasury note yields now at 2.25%, and so they are certainly not telling you that we’re into some new sustainable growth and inflation phase.

For people who started to invest around the politics, right after the U.S. election, what a mistake that ultimately proved to be.

I was a skeptic to begin with, because I did research on data all the way back to Ulysses Grant, and saw that even the most effective presidents barely succeed in legislating half of what they campaigned on, whether they have a one-party rule or not.

So, in this case, what half will you invest around Donald Trump? We see what’s happening with health care, we see an eventual non-event around tax reform, though of course there are things he can do in terms of deregulation that would spin the dial a few basis points on economic growth.

Nothing big ever happens in the United States unless you get 50 votes to the Senate.

The Truth Is in the Bond Market

Douglas Goldstein: Let’s go back a little bit and understand where someone can look to get a better understanding of what’s truly going on. You say the truth is in the bond market. What does that really mean?

David Rosenberg: It means that the most liquid part of the capital markets, and historically when you’re taking a look at either coming out of recession, going into recession, or anywhere across the business cycle, the bond market is giving you a clue, and the shape of the yield curve is giving you a clue as to where exactly you are in the business cycle.

Ask yourself, are inflationary pressures building, is this a signpost to be big on growth, big on cyclicals, or does it mean you should start to become a little more defensive?

I have observed that when people talk about the markets being a leading indicator for the economy, what ultimately leads the stock market is the bond market. So, focus on what the bonds yield is telling you.

The view was that the bond was going to go up and stay up, but if that were indeed the case, you would have had a big inflationary trade going on, and you would have invested around markets globally and across the capital structure, but that hasn’t happened.

In other words, the bond market is always the market you want to look at, in terms of understanding the stock market.

Identify the indicators across different asset classes that you want to invest in, and of course what your view on the economy is going to be.

The stock market has done well, and not every single part of the stock market’s done as well as others, but the bond market right now is telling you, as an equity investor, to tread very cautiously.

The bond market’s telling you as an equity investor that the risks that we’re going to be seeing, the earnings growth that’s embedded in stock broking valuation right now, the odds that we see that over the next four quarters, is actually pretty low.

That tells me that you want to be pretty conservative when it comes to equity investing, and that’s the message from the bond market right now.

Where to Invest for Income

Douglas Goldstein: David, I want to talk a little more tachlis, because a lot of people who are investing are investing because they need income, and quite frankly with a low interest rate environment, they are short. They can’t get income to live on their portfolios and then they’re hearing these rumors that the bond market’s about to collapse.

They don’t know where to put their money because, as you said, if the bond market is leading and it collapses, it’s certainly not a good sign for the stock market.

What can normal people do, who need income off their investments as well, as opposed to looking for growth?

David Rosenberg: Okay. Well, I’ll make this comment strictly for the few people out there that truly are normal. We always try to find out what the norm is.

I think that that is actually the big challenge. We are in a classic deflationary phase, where coupled with demographics, excess of debt loads globally means that interest rates are going to stay low for an extended period of time.

This always happens after an epic asset and credit collapse like we endured in 2007/ 2008 - 2009. We saw this in the 1830s, the 1870s, 1907 collapse, and the 1930s.

We’re going to be in this period of challenging investment environment for an extended period of time, when it comes to interest rates.

Investing for Cash Flow

David Rosenberg: Unfortunately, what’s happening is that the baby boomers in the United States, the 78 million pig in a python, just turned 70 in the past year, so we are at this demographic bulge right now that historically is craving income and recurring reliable cash flows to help fund their retirement.

This is actually a very big challenge. It’s a great point, and it’s one reason why, despite the fact that I’m very cautious of the stock market, the parts of the stock market that I like are the parts that generate debt income.

For example, you can do a lot worse than invest in Canadian banks. They will pay you a 4% yield, and not just a yield but characteristically, very strong dividend growth.

That’s the part of the market. I look at the financials in the United States, of course much more regulated today than they were in the last cycle, and that’s probably a good thing, but now they’re paying out dividends.

Their dividend yield’s going up, so I find that if you’re going to be looking at parts of the capital structure; parts of the stock market that I like, it is dividend growth and dividend yield characteristics.

The financials in North America and for your listeners in Israel, as far as you can capture that, the financials in North America, are a very good place to be. They are a nice surrogate for investing in the bond market, where yields are obviously unacceptably low for a whole range of people out there.

North American Commercial Banking System Is Strong

Douglas Goldstein: So, you don’t feel, if there’s some sort of market collapse, the financials, like 10 years ago, are going to be the first ones to take it on the chin?

David Rosenberg: I was looking at a bunch of charts, in the U.S. today, looking at the parts of the low ratios, delinquency rates, tier one, and core capital asset ratios.

Invariably, when the Fed is raising interest rates, as has been the case recently, you tend to get a financial accident, but these financial accidents, cycle to cycle, never happen in the same place. It’s like lightning does not strike twice.

The next bubble, wherever it bursts, may be in commercial real estate or REITs in sub-prime autos, but it’s not going to be in the residential market like it was in the last cycle.

It’s probably not going to be in the U.S. commercial banking system. It’ll be somewhere else.

There is some bubble, obviously, in these very whippy growth stocks, in these bank stocks that have a 70 multiple collectively, and they remind me of the nifty 50 back in the 1970s.

Commercial real estate looks bubbly to me, and sub-prime autos is an area that looks problematic, but what I am saying is that these are not areas that are going to bring down the banking system.

Regulation Helps the Banking System

The banks in the United States have become regulated utilities. The difference is that the authorities are now letting them pay out dividends to shareholders.

Take a look at where you want to be situated, in sectors where you’re going to be seeing the business operators returning capital to the shareholders over time.

I think that the financials today, the U.S. financials, regional banks, the large investment commercial banks, are much safer places to be than they were obviously a decade ago, and maybe at any time since we had the stable period of the 1950s and 60s.

The banks have become regulated utilities, which means that the growth of their balance sheets is going to be constrained. But for aging - not aged baby boomers - who are seeking income as a refuge from what you can no longer get in the government bond market like you used to, the bank stocks - and I take that in relation to the fact that you are taking on some capital risk - are, I think, a very prudent place to be putting capital right now is in financials.

Both sides of the border in North America too. The Canadian banks are rock solid, plus you’d be investing in a currency, the Canadian dollar, that’s entered into a new bull market, something that people on your show should be looking at right now.

Douglas Goldstein: Dave, this has really been fascinating. Unfortunately, we’re just about to run out of time. So tell me in the last few seconds, how can people follow you and follow your work?

How to Follow David Rosenberg

David Rosenberg: I produce a daily called Breakfast with Dave. I’ve been doing this daily market and economic commentary since 1998. If you want to email me directly, the best thing to do is to email me at drosenberg@gluskinsheff.comor just go on the Gluskin Sheff website and you can find me there.

Douglas Goldstein: David Rosenberg, thanks so much for taking the time.

David Rosenberg: My pleasure.