Merrill Pundits Say Worst Is Yet to Come
By Igor Greenwald |AS COMPANIES GO, Merrill Lynch (MER) is having a rough decade. The firm that once boasted of being "Bullish on America" was reduced late last year to reassuring worried clients that it's still "Bullish on Merrill Lynch," despite all those lost billions.
And yet, had former Chief Executive Stan O'Neal listened to his most prescient hired hands, he might still be lording it over Ma Merrill instead of testifying about golden parachutes before Congress.
For years now, Merrill Chief Investment Strategist Richard Bernstein has been warning clients that the rush into riskier assets would end badly. For years, Merrill's chief North American economist David Rosenberg has argued that consumers were taking on more debt than they could reasonably hope to repay. The irony of these guys fronting a major Wall Street firm still crippled by its involvement with yesteryear's credit craze is almost too rich for words.
And yet there they are, churning out a steady stream of ideas that would be hard to sell in a 60-second TV spot. Their unvarnished views cannot be very pleasant reading for Merrill's 16,000-plus "private client financial advisors." Don't these two know that Wall Street has become the butt of mordant jokes, the presumed refuge of degenerates out to rip off the conscientious do-it-yourselfer?
Actually, these guys may not. Bernstein is 49 and Rosenberg 47, and they started in the business before amateur hour truly arrived. Henry Blodget had not yet derided in private emails the same risky Internet stocks he was flogging on Merrill's behalf to Mom and Pop day trader. Jim Cramer was not yet tempting college kids into trying their luck against hedge funds.
Bernstein already sensed the battle was lost seven years ago, when he published a book called "Navigate the Noise: Investing in the New Age of Media and Hype." Since then, the hype, what Bernstein calls "the insidious effect that tries to get you to believe that the next 10 minutes is dramatically different from the last 10 minutes," has only grown more pervasive.
"For an individual investor, the notion of being able to trade stocks successfully is just generally pure folly," he says. "You'd think that with what went on with day trading and the Internet and what's just gone with the bubble in housing people would realize that managing your wealth is a little more difficult than they thought."
Actually, Bernstein says, it's not so hard, if you follow his three simple steps to wealth creation. He reels them off — diversify, extend your time horizons, reinvest your dividends — and punctuates each step with a lament about how "nobody ever does that."
Instead, people go running for what's hot: housing yesterday, commodities today, perhaps bonds tomorrow. "If your asset allocation is correct then day-to-day, week-to-week or even month-to-month gyrations of the market should have no impact on your ability to sleep at night," Bernstein says. "And if it does then it says that something is wrong. Now, unfortunately what's happened is, people have taken more and more risk because they want higher returns because they don't want to save as much."
Enter Rosenberg, who's made the undersaved, overborrowed consumer the linchpin of his early and accurate recession call. What he describes is not just your garden-variety recession either, but possibly a downturn as nasty in its own way as the 1973-75 attack of stagflation.
"This is not your father's recession of the 1950s and 60s that was brought on by excessive manufacturing inventories, this is not your big brother's recession brought on by excessive inflation and interest rates. This is a balance sheet recession in the consumer sector and the financial sector. Balance sheet recessions are very tricky things," Rosenberg says.
"We have a situation now that, even with interest rates being cut so aggressively by the Fed, that the ratio of interest and principal payments to the disposable income in the household sector at 14.3% is at an all-time high. On the eve of a recession. Sounds unbelievable."
Rosenberg draws on his own childhood for a bit of perspective that the median 36-year-old portfolio manager might be missing. He grew up the youngest of four children with a father who was raised during the Depression.
"You never in my household threw away a ketchup bottle without my dad examining it," Rosenberg recalls. "And invariably he'd stick in some water, shake it and then you knew it looked a little runny next to your french fries, but it still worked."
"And then take a look how the boomers lived and how they brought up their children. People don't believe that people have the capacity to change, but they do. And here I'm going to tell you that the whole full new macro theme is going to be about getting small. The banks are going to be getting smaller. The home builders are getting smaller. And we're going to find that consumers are getting smaller."
"I know that's hard to believe, but this is a secular shift — we're going to find both the demand and the supply of credit contracting. But we're going to come out of it much healthier."
Rosenberg's workweeks start in his hometown of Toronto at 4 a.m. — and they're liable to end, to the degree that they end at all, in an airport lounge halfway across the globe. He uses the early-morning darkness to pen a briefing note that has become "a labor of love" over the last decade. The rest of the week gets spent on the more in-depth research and meetings with far-flung clients "who want to look at the whites of your eyes."
Perhaps because he's a Canadian, or possibly due to all the travel, Rosenberg has no time for the doctrine of American exceptionalism, at least as it applies to consumer spending: "People believe that there's something inherently special about the American consumer, but the only thing special is that the average adult in the United States owns six credit cards. The only difference is the access to credit."
All that cheap credit is what led Rosenberg to consistently underestimate the U.S. growth rate in recent years, one reason he gets labeled a "permabear." In fact, the economist freely acknowledges the error of his ways. "I made a pledge to myself that, although I missed the extent of the credit bubble on the way up, it would be folly to underestimate the power of a post-bubble deleveraging process, which is what we're in right now."
It's the sort of plain, no-pretense talk that permeates his writing and that of Bernstein, who calls Rosenberg "a very close buddy" as well as one of the smartest people he's worked with. It doesn't take a long chat with either man to be charmed by their enthusiasm for the topic at hand, the willingness to admit that they've been wrong and the reluctance to engage in I told you so's.
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"Everybody likes to say that they're for the market mechanism, until they lose their job. So I think it's very easy to say that, but realistically it's not the right way to go. There has to be an element of social responsibility here." "No one has a copyright on being correct," Bernstein says. "And so when people disagree with me the most is probably when I'll listen to them the most. We all have this tendency to say, 'Oh, what a nut job — what does he know?' Well, when I find myself saying that in my head I always stop and that's the person I actually want to listen to."
This means he'd probably give his undivided attention to anyone claiming that by year's end the economy and the market will be hunky-dory. This tends not to be how credit bubbles or global asset deflations end, and neither man holds out much hope that the latest Fed interventions will make everything alright in a hurry. Ultimately, they believe, the government and taxpayers will get saddled with the bill, adding to the imperative to save.
"Everybody likes to say that they're for the market mechanism, until they lose their job, Bernstein says, chuckling. "So I think it's very easy to say that, but realistically it's not the right way to go. There has to be an element of social responsibility here."
This kind of talk is a rare clue to Bernstein's political predilections; another can be found in records of past contributions to Democratic campaign causes. He won't talk politics, and says his have nothing to do with his professional views: "Any good analyst has to be incredibly good at compartmentalizing, because the last thing you want is for your own emotions or your own beliefs to cloud what's going on. That's not a good way to make money for people."
In these times especially, it's easy to grow cynical about Wall Street's role and the supposed value it adds to the function of rational resource allocation. I've written before about how easy it is to get burned by self-interested financial intermediaries, and so have better writers worth trusting on this issue.
But when Rosenberg talks about "the role I'm privileged to have — underline the word privileged," there's no doubting his sincerity. Nor is there doubting Bernstein when he says that "if you're going to be objective as I try to be, you will naturally go against the flow." And if people don't like that, too bad — the interests of clients come first. He got used to the hate mail in the days of the dot-com bubble.
I like low-cost index funds and ETFs as much as the next guy, and don't think most of what passes for investing advice is worth much of anything at all. But I'd gladly pay for what I've learned from Merrill's bears. Too bad it would never fly in a TV commercial.
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