Wednesday, January 25, 2012

David Rosenberg: Volatility is the New Normal

ZeroHedge published David Rosenberg's note today, and it's a must-read. In it, Rosie contends that the volatility we witnessed in 2011 is the normal state of affairs for a deleveraging world and we are still in the early innings of this cycle. His investment themes for this state of affairs include (verbatim from ZH):

1.    Market volatility is part and parcel of every post-bubble deleveraging cycle. This means an ongoing focus on long-short relative value strategies that have little directional exposure with the overall market but take advantage of the inherent mispricing across sectors during these periods of heightened volatility.

2.    Deflation trumps inflation as the primary trend in a deleveraging cycle. This means an emphasis on defensive sectors with earnings stability and predictability characteristics. It also means a focus on squeezing as much income as possible out of the portfolio. This is why "income equity" strategies make so much sense.

3.    Balance sheet quality becomes so much more important in cycles like these. Already, we have seen the amount of AAA-rated government paper plunge 70% in the past three years from $19 trillion to $6 trillion. As such, emphasis on good quality corporate bonds in noncyclical sectors, attractive spreads, high net free cash flow yields, low debt ratios, high liquidity ratios and light refinancing calendars make prudent sense. Our good friend and top-ranked credit analyst Marty Fridson told me yesterday that even in the high-yield space, spreads off of government bonds have more than 100 basis points of tightening potential based on the current set of fundamentals.

4.    Always be on the lookout for assets priced for recession. Not only are wide swaths of the credit market priced for such, but so are parts of the commodity complex and segments of the ex-North American equity market where P/E ratios are in single-digits and PEG (P/E to growth) ratios below unity.

5.    In this post-bubble environment, policy rates will remain near the floor for years. As such, the risks of any sustainable bear market in bonds are very low since the cost of carry is so vitally important to the fixed-income markets, especially for longer duration product (keeping in mind that yield curves are still steep by historical standards).

6.    Keeping policy rates low means that real rates will remain negative. Even if the CPI turns negative, the central banks around the world will de facto ease policy by printing money. In this sense, the secular bull market in gold bullion remains intact and, as such, dips should be bought (especially dips below the moving averages).

7.    Global deleveraging cycles almost invariably bring on heightened geo-political tensions. This is why the oil price has such a high floor established underneath it. Protectionism will continue to emerge as a new normal, as part of the globalization trend gets reversed. Exposure to crude oil and materials makes good sense from a strategic point of view.

8.    Populist policies win the roost in these types of cycles. The 99% extract their pound of flesh from the 1%. Conservatives like Newt end up sounding like Krugman when debating the likes of Romney. Luxury retailing, or any other fashion that benefits from the spending trend of the upper class, is probably a good shorting opportunity.

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