David Rosenberg: Buy Bonds Not Stocks

While I don't always agree with him, David Rosenberg is worth following if you want to hear the deflation case. Despite surging commodity prices, Rosenberg is still in the deflation camp and is expecting the 10 year treasury to fall below 2% in 2011. He says weak growth and low inflation should make bonds outperform stocks. One thing I never understood about Rosenberg is why he places so much trust in the government's inflation number. Usually, he is very critical of government data and questions its validity, but he apparently has full faith in the inflation number as a justification for buying bonds. Still I think he has one good point that reduced spending from state and local government will put pressure on US growth in 2011. From Dow Jones:

Rosenberg said in an interview with Dow Jones Newswires on Monday that safe-haven Treasury bonds provide better value than U.S. stocks. He especially favors 30-year Treasurys.

This assessment runs starkly in contrast with that of Goldman Sachs Asset Management Chairman Jim O'Neill's, another high-profile market participant, who said in an interview last week that he favors stocks based on an upbeat global economic outlook.

But Rosenberg argued that the U.S. has passed the peaks of the economic cycle and fiscal stimulus and noted that there are fresh headwinds ahead. He highlighted the spending cuts from state and municipal governments, the second-largest contributor to U.S. gross domestic product after consumer spending.

"Next year or two, you are going to see draconian cutbacks, which will have a reverberation through the broader economy. The pullbacks from state and local governments have already started," said Rosenberg. "Even if we avoid a double-dip recession, my sense is that growth will be sufficiently weak" to support my view that Treasurys will outperform stocks.

Rosenberg expects the U.S. to clock growth of 2% in 2011. O'Neill, in contrast, predicts a figure closer to 3%.
The weakening outlook is likely to suppress inflation further, said Rosenberg, noting that the core consumer price index, which excludes energy and food, rose only 0.6% last month compared with a year earlier. That was the lowest level for this adjusted indicator since records began in 1957.

Should the disinflation trend persist, Rosenberg said, the core inflation rate could fall below zero by the end of the second quarter of 2011. Over the past few months it has held below 1%.

That would trigger concerns about deflation, a phenomenon that discourages consumer spending and business investment, much as it has done in Japan since the 1990s. The Federal Reserve launched a program to buy $600 billion in Treasury bonds earlier this month aiming partly at warding off such a threat.

In any case, with inflation virtually nonexistent, Rosenberg said that 30-year Treasury bonds, including similar-maturity zero-coupon bonds, provide attractive value for investors seeking to preserve capital in a weakening economy. Inflation eats into bonds' fixed returns over time, so when it is low it boosts the appeal of holding longer-dated securities.

Rosenberg expects the 30-year bond's yield, which moves inversely to its price, to fall to 2.5% to 2.75% by the end of 2011 compared with 4.234% traded recently on Monday.

Meanwhile, he stuck to his forecast for the benchmark 10-year note's yield to fall below 2% in the coming year and predicted a range of 1.75% to 2% by the end of 2011. That forecast makes him one of the biggest Treasury bulls on Wall Street. The 10-year note recently yielded 2.840% Monday.

While the weak U.S. economic outlook may weigh on the dollar, Rosenberg said he is more upbeat about the dollar over the next year or two than the euro, given that the common currency faces sovereign debt problems.

"I expect the roller-coaster ride in the euro/dollar to continue in the coming year, given the different factors in play. But my money will be more on the dollar than the euro," he said, predicting a range of $1.20 to $1.40 per euro for 2011 with a tendency toward the lower end of the range by the end of the year.

For the broad foreign exchange markets, Rosenberg said he likes currencies in countries with strong balance sheet qualities, meaning a strong growth outlook and sound fiscal health, such as Norway, Sweden and Canada.

He said he is especially bullish on the Canadian dollar, betting that the currency will gain 20% against its U.S. counterpart over the next five years, even though the appreciation won't occur in a straight line.


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