Wall Street Legend: This Market Just Flashed a Huge Warning Signal

Wall Street Legend: This Market Just Flashed a Huge Warning Signal By Tom Dyson Tuesday, August 17, 2010

David Rosenberg calls it the smoking gun… Rosenberg and I just spoke on the phone. You might not know his story, but David Rosenberg is a Wall Street legend. He is famous for being a bearish economist at the most bullish firm on Wall Street. When the housing market was in a roaring boom, Merrill Lynch was making billions. But Rosenberg, Merrill's chief economist, was warning about recession and a bear market in stocks. He said the housing and mortgage bubble would pop and a severe economic downturn would follow. Last year, he quit Merrill Lynch. Many people thought Merrill fired him for not being bullish enough. "That's nonsense," he told me. "My wife and three kids live in Toronto. I wanted to be with them. So I left New York." He's now Chief Economist at Gluskin Sheff, a boutique money-management firm in Canada. Of course, Rosenberg's bearish views were spectacularly right… Rosenberg is now one of the most popular economists in the media. You'll often find him giving an interview on CNBC or a quote to the Wall Street Journal. So what's Rosenberg's smoking gun? It's the bond market. First, check out this chart of the yield on the 10-year Treasury note. It's collapsing… now at March 2009 levels. Some markets are smarter than others. Lumber is a great leading indicator of the housing market. The Baltic Dry Index often leads the shipping stocks. Rosenberg says the bond market is smarter than the stock market. Rosenberg writes a great, free daily newsletter, Breakfast With Dave, where he summarizes and comments on all the major economic news of the day. In one of his issues last week, he showed that whenever the economy heads into a downturn, bond traders start anticipating the recession before the stock market. Take the 1990 recession, for example. The 10-year note yield peaked on May 2, 1990 at 9.09%. The S&P 500 peaked two months later… In the 2001 recession, the 10-year yield topped out on January 20, 2000 at 6.79%. The stock market peaked eight months later, on September 1, 2000. In the 2008 recession, the 10-year yield reached its high on June 12, 2007. The S&P 500 peaked on October 9, 2007, a few months later… And finally, the smoking gun for the 2010 recession… The 10-year Treasury yield peaked on April 5 at 3.99%. It's now at 2.60% four months later. The stock market peaked on April 26, three weeks later… In other words, if the action in the bond pits is any guide, the economy is going back into recession. I asked Rosenberg what investors should do about this. He likes gold and the highest-quality natural resource companies. But bonds are his favorite investments. He says most people think cash is king. But they're wrong. In a deflationary recession, income is king. He calls his strategy "SIRP," which stands for Safety and Income at a Reasonable Price. Rosenberg thinks interest rates will continue to decline like they did in Japan, and bond investments will continue to rise in value. Corporate bonds are his favorite. Rosenberg says American corporate balance sheets are loaded with cash and extremely healthy, so corporate bonds are safe. Good investing, Tom