In his forecasts for 2018, David Rosenberg, chief economist and strategist at Gluskin Sheff warned his clients – and our readers – that they should “enjoy the next 12 months” because contemporary market conditions, characterized by investor complacency, volatility, high valuations and a tight labor market, are eerily similar to 1988, 1999 and 2006 – years that immediately preceded major market reversals.
Given these similarities, Rosenberg concluded that “we are 90% through the current cycle” and advised that clients should focus on counter-cyclical companies with strong balance sheets…or consider deploying their money outside the US.
However, in a note to clients published Thursday, Rosenberg added that the Jerome Powell Fed could make a policy error that inadvertently sets the market up for a painful drop.
In his note, Rosenberg wondered whether the Fed will “remain a serial bubble blower.”
“The elephant in the living room remains the central banks,” Rosenberg wrote. “The prevailing view is that balance sheet tapering will be mild and that Jerome Powell will prove to be a dove. This may well be the most important psychological driver for the market — that a new and inexperienced Fed will not take the punchbowl away in the coming year.”
The Fed has been misguided, Rosenberg says, by its inflation target of 2% growth, which it has failed to reach despite a decade of historically accommodative policy. And investors have entered the year believing that the Fed will more or less stick to its projections (something that, in the past, it has proven unwilling to do).
But, as Bank of America highlighted earlier today, financial conditions are looser today than when the Fed starting reining in its post-crisis money printing program – despite the central bank hiking interest rates now fewer than six times.
With this in mind, Rosenberg worries that Powell could overreact and raise interest rates too quickly, causing the asset bubble in equities (and presumably bonds as well) to burst.
Earlier today, outgoing New York Fed Chairman William Dudley said something similar. The fact that monetary conditions have remained lax “suggests that the Federal Reserve may have to press harder on the brakes at some point over the next few years. If that happens, the risk of a hard landing will increase.”
Rosenberg admitted that GMO’s Jeremy Grantham “might be onto something” with a theory that he published yesterday in a research note of his own.
In it, Grantham posits that a cautious Fed could set the market up for a “late bubble surge” causing equity price gains to accelerate and the market to climb another 60% before valuations come crashing back to earth.