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David Rosenberg: The Potemkin Rally

  • Written by Syndicated Publisher 1 Comment1 Comment Comments
    May 7, 2013

    In Part V of the series of reports from the 10th annual Strategic Investment Conference, presented by Altegis Investments and John Mauldin, David Rosenberg presents a rather shocking shift from his primary thesis over the last 3 years.

    You can read the previous presentations by clicking the links below.

    Part I: Niall Ferguson – The Great Degeneration

    Part II: Jeff Gundlach – Why Own Bonds At All

    Part III: A. Gary Shilling – Six Realities In An Age Of Deleveraging

    Part IV: Mohamed El-Erian – Putting It All Together

    David Rosenberg is the Chief Economist and Strategist for Gluskin-Sheff. Here are his views:

    “I have good news and bad news.

    First the bad news.   I am getting divorced.

    That’s right…my 25 year love affair with the bond market is over.

    The good news is that Gary Shilling and Lacy Hunt have said they will stay friends with me.”

    The Potemkin Rally

    {StreettalkLive Note:  At the end of David’s speech he stated that this is a “coffee table” presentation.  This view will likely take some time to develop and that from time to time we will need to reveiw it to see where we are.   This should not be taken as something that he expects to happen tomorrow.}

    We currently are witnessing the Potemkin rally. For a quick background the phrasePotemkin villages was originally used to describe a fake village, built only to impress. According to the story, Russian minister Grigory Potemkin who led the Crimean military campaign erected fake settlements along the banks of the Dnieper River in order to fool Empress Catherine II during her visit to Crimea in 1787.

    The term, however, is now used, typically in politics and economics, to describe any construction (literal or figurative) built solely to deceive others into thinking that some situation is better than it really is.

    Ben Bernanke, recently proclaimed “The Hero” by Atlantic Magazine, is the “Wizard of Potemkin.”

    Since 2009 Bernanke has engage in massive monetary experiments. These experiments lead to future dislocations. The chart below shows that for every dollar increase in the Fed’s balance sheet it has translated into $1 of NYSE market capitalization to GDP.


    There is no doubt that the Fed wants inflation. The problem is they may get more than they ask for.

    The Potemkin Economic Recovery

    We are currently witnessing the slowest economic recovery of any post-WWII period.

    However, It is important to challenge your thought process. Read material that challenges your views.   Here are my rules.


    Bob Farrell once stated that

    “…when all experts agree something else is bound to happen.”

    The reason my love affair has ended with bonds is that deflation has become the consensus view. Take a look at the following chart which shows that 80% of shortfall in growth is caused by slower potential.


    There has been a secular decline in Potential GDP growth.

    Here is a question for you. How does 1.8% GDP growth rate over the last year drop the unemployment rate by 60 basis points from 8.1 to 7.5%? That math simply doesn’t work.

    The growth rate of GDP has fallen significantly and this should not be ignored.   Historically, the economy could grow at 4% without creating inflation. With the current makeup of the economy today that is no longer possible. This is why we are likely witnessing the early stages of the transition from deflation to inflation and the end of my “love affair” with bonds.

    One of the factors that will be supportive of an economic push will be the end of the household deleveraging cycle. I think that the end of the deleveraging cycle is about 2 years away. As you can see in the next slide borrowing has started to rise once again and will be a tailwind for the economy. This has been the primary goal of the Fed’s QE programs – boost asset prices to stimulate consumer confidence and borrowing. There is a problem though.


    We have the weakest growth in the private capital stock in 60 years.   Business spending as a share of GDP is at recession levels


    While consumer confidence may improve as asset prices are inflated. It is not the same for CEO’s who are unlikely to make a commitment to the economy anytime soon.   The NFIB survey shows that government regulations are a top concern that is inhibiting investment.

    With capital formation low, which drags on productivity, it keeps the labor market weak.  The labor market is plagued by a structural shift in its makeup and type of jobs available.

    There are currently more than 90 million people outside the labor force and the available labor supply is shrinking.


    Here is the reality. In the last four years we have created 3 million jobs while more 9 million people left the labor force.

    The latest employment report showed a rise in employment and a fall in the employment rate. However, the household report showed a surge in the number of “self-employed” – these are individuals who are likely working out of their basement with no customers.

    If you take a look at the JOLTS survey you will see that companies are looking for workers. Job openings have been on the rise. However, as we have seen in the recent NFIB surveys they cannot find the skilled workers to fill those jobs. This is why layoffs and discharges are at record lows.


    Streettalk Note: This is known as “’Labor Hoarding” which is also why we are seeing jobless claims fall without substantive increases in employment. Fewer layoffs leads to lower claims but full-time employment relative to the population remains close to 2009 lows.

    Here is my contention. At 7.5 % unemployment we are likely much closer to full employment than the Fed believes. The number of firings is 10% lower now than it was when the unemployment rate was at 4.4%. Think about that.

    This is why the workweek has begun to expand. Businesses are running at minimum levels of employment so they are working current employment longer. This is leading to rising wages which is one of the key components of inflation.


    Productivity growth is heading lower because of lack of capital formation. However, unit labor costs are rising which, as I said, has a high correlation to inflation.  The bad news is that rising wage costs negatively impact profit margins.


    The Fed funds rate has been pushed to zero. During that same period the Fed’s balance sheet has exploded. Just FYI – the fed’s balance sheet has jumped by 40% at an annual rate in the last 3 months which is why the market has hit new highs.   The bottom line is that the Fed’s balance sheet is replacing the fed funds rate.   Ben wants assets to go up to stimulate confidence.


    However, the most compelling argument for stocks – yield spread.

    But think about this – junk bonds are trading with a yield of 5% – really?  That’s where AAA treasuries were 5 years ago.  What is that telling you about investor risk taking?

    Here is another question?  What correlates with bond yields the closest? You guessed it – Fed policy.


    The Fed has been talking about the Journey since 2009.   Now they are talking about the destination with specific targets on inflation and employment.   However, the problem for the Fed is that they may get more than they wish for.   When inflation begins to rise it is extremely hard to stop.

    While I agree that the Fed should be stimulative…the extent of the stimulative action so far has been too radical. This will lead to inflation in the future.

    Currently, the U.S. is sporting a near 6% output gap. The problem is that an output gap of nearly 6% doesn’t correspond with a 1.6% inflation rate.   At that level we should be seeing negative inflation rates. From my work I think that the output gap is more likely 2-3% which means that the Fed should be tapering off their actions now…rather than later.

    Here is the problem currently. The real fed funds rate is very negative. The last time this occurred was when Author Burns was Fed chairman. The following two decades were not kind.


    Furthermore, negative real rates in the past…


    …have always led to asset bubbles.


    The reason I am getting divorced from my love affair with bonds is that when inflation eventually rears its head – those individuals long high yield bonds, and unhedged, will lose.

    My view since joining Gluskin-Sheff has been “Safety & Income At A Reasonable Price”which I am now shifting to “H.I.R.P – Hedged Inflation Risk Protection.” 

    These are the areas that should perform the best should this longer term view of the world begin to develop.

    • Real Estate
    • TIPS
    • Art/Collectibles
    • Gold/Silver
    • Banks
    • Staples
    • Energy
    • Metals
    • Agriculture
    • Credit Arbitrage
    • Long-Short Strategies
    • Volatility
    • Lonnie/Aussie/Kiwi

    Equity Sector Selection In A Cost-Push Stagflation Environment

    • Staples
    • Consumer Discretionary
    • Utilities
    • Telecom
    • Cable/Media
    • Oil & Gas
    • Industrial Conglomerates /Electrical Power
    • Road & Railroads
    • Machinery
    • Airlines
    • Basic Materials
    • Precious metals
    • Specialty chemicals
    • Paper packaging.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of Streettalk Live

    lance robertsAfter having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.


  1. #1 rwmccoy
    May 8, 2013 pm31 12:16 PM

    9 million people have not left the labor force as the writer contends. I suggest he picks up a copy of ‘The Stealth of Nations’ by Robert Neuwirth. It may change his outlook radically. These people may have left the ‘official’ workforce. The underground economy is alive and well in the US and elsewhere. I have a nagging suspicion it is growing far beyond what experts believe. Of course that cannot be ‘officially’ counted, and if these people succeed, they may not want to come back.

    Deflation is not the consensus view in some quarters. Please see William Cody’s, the Cody Word on Marketwatch. May 7, 3013.

    love the quote by Bob Farrel about experts agreeing.

    By the way it’s ‘Loonie’ not ‘Lonnie’. The Canadian in me can’t stand such an egregious error about our wonderful Loonie/Toonies.


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