Running out of bullets

If you're looking for worst-case scenarios, David Rosenberg is your man. The former Merrill Lynch economist was one of the loudest voices warning of a deep and painful recession in 2007, when stocks were flirting with record highs. Since then, he has been one of the few skeptics willing to take a stand against the army of dreamy romantics down on Wall Street. Now at Gluskin Sheff, a wealth-management firm in Toronto, Rosenberg still sees plenty wrong with the economy. And he's been underwhelmed by the bounce back we've seen over the past year. His research suggests the recovery has been a mix of one part inventory restocking and three parts government stimulus. Unfortunately, the government is now transitioning from a benevolent force for growth to a malevolent one, with taxes set to rise and spending cut. Political reality means that a second stimulus package isn't coming.

Historically, a typical inventory-and-manufacturing-based recession lasts four to five quarters and is followed by robust economic growth. But history teaches us that in the wake of credit bubbles like the one that fueled the housing bonanza, economies tend to stall for up to seven years as a financial crisis heals. To speed the recovery, global policymakers threw everything they could at the problem. But it just won't go away. The Federal Reserve's balance sheet has swelled to more than $2.3 trillion in assets, up more than 170% from pre-crisis levels. Fresh dollars printed and injected into the economy count as liabilities; bonds purchased to put cash into the system add to the Fed's assets. This gives you an idea of how hard the Fed is working to jolt the economy back to life.

The U.S. government deficit has swelled to more than 10% of the gross domestic product because of desperate stimulus spending. Consumers have been encouraged to buy houses, cars and appliances. Rosenberg quips: "What bullets are left in the chamber?"

Sure, maybe the Fed can just keep papering over the problem. Or maybe the rise of China and India will boost the fortunes of America's exports and save us all. For his part, Rosenberg believes that "Mother Nature has to run its course." He says there is too much debt in the household and government sectors, and that it needs to be paid down the hard way: through spending cuts. And that means the next sustainable bull market won't arrive until 2012 at the earliest, according to Rosenberg.

His advice to investors is to "squeeze as much income out of the portfolio as possible." He recommends high-quality corporate bonds as well as high-yield equities such as real-estate investment trusts and master limited partnerships in the energy space. Examples include Enbridge Energy Partners (EEP, news, msgs) and Vornado Realty Trust (VNO, news, msgs). Also consider preferred shares, which sit between bonds and equities. They are riskier than bonds but offer higher returns. The PowerShares Preferred Portfolio (PGX, news, msgs) ETF is a quick and easy way to get broad exposure to this asset class. The fund offers a yield of 7.4% and has a heavy allocation to the financial sector.

But Dow 1,000? Really?

Prechter, by the way, told The Times that average investors should flee to cash and cash equivalents, such as Treasury bonds, for the foreseeable future. The more skilled could dabble in shorting and other strategies for falling markets. Other pessimists aren't quite so negative and question that advice. Rosenberg says Pretcher's call is "too dire" and thinks cash isn't a realistic alternative for investors, because it earns next to nothing with interest rates as low as they are now. Nenner doesn't see the Dow moving below 5,000. Nenner also believes interbank lending rates will rise to a peak in October before sliding back toward zero, so if you have a wad of cash and want to put it in a certificate of deposit, you'd want to wait to pick up a bit more yield.

In fact, all this is fairly standard down-market advice, and if things get really bad, it'll be hard to find any safe place to hide.

For what it's worth, Wall Street doesn't think it's time to panic. In a note to its Asian clients this week, Goldman Sachs strategists highlighted Prechter's Dow 1,000 call as a sign the bearish camp has become crowded again, with deflation and austerity as its universal catchphrases. With measures of retail investor sentiment at very low levels and stocks well off their highs, the Goldman camp believes stocks have appropriately discounted the economic slowdown we've seen. That means equities are poised to move higher as the news flow turns positive.