Marketwatch Talks with Gary Shilling

August 21, 2011

6 minute read

While Gary Shilling is less of a trader, and more of a macro guy his long term views continue to be more 'right' then 'wrong' although he has suffered through some market action that has gone against him as never seen before levels of government and central bank intervention created a hazy shade of steroid injections globally. But such calls as remaining long U.S. bonds, ultimately, have been proven correct. Ironically he has a 180 degree different view on US Treasuries (and stocks) than Faber. I share some views with both at this moment...

Marketwatch likewise has '5 moves' Shilling is offering for investors.

Stock investors are suffering as shocked markets grapple with the grim prospect of another U.S. economic recession, but anyone paying attention to economist A. Gary Shilling can say he saw this coming. Shilling is president of economic consulting firm A. Gary Shilling & Co. and author of the recently published “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth.”
He’s long predicted that the Federal Reserve’s efforts to stimulate the U.S. economy would fall short, and that a global stock market fueled by cheap money and a government-engineered bailout would come to no good end. For Shilling, the U.S. economy sliding into recession within 12 months is a matter of when, not if. “Recession is more likely than not,” Shilling said.

It wouldn’t take much for a vulnerable economy to slide into recession, he added. That shove could come from “another big nosedive” in the fragile housing sector, Shilling said — sending average home values down as much as 20%. “We going to see a pickup in foreclosures and a lot more houses dumped on the market,” he added. In fact, the economy could be in recession now, Shilling noted.
Shilling guesses that official quarterly U.S. growth figures will be revised downward in coming months. Said Shilling: “The odds are that next time they revise the data it will be to make it even weaker. We could be looking at numbers that are positive but may not be six months from now.”
The major drag on economic growth is consumer debt, Shilling said. There’s just too much of it — the detritus from years of easy borrowing that Shilling expects will take the better part of this decade to unwind. Accordingly, constrained consumer spending and higher household savings makes a Japan-style deflation — declining prices for many goods and services — a more likely scenario for the U.S. in Shilling’s view than inflation.
Investing in such a slow- or no-growth environment requires what amounts to a full reversal from recent years. Defensive, capital preservation takes precedence over risk-taking. Bonds — especially Treasurys — rule. Cash is not trash, but home ownership is. Commodities and emerging markets take a big hit. And stock investors pile into the biggest, strongest and richest corporate boats.
“The economies of the world are slipping,” Shilling said. “We are going through this deleveraging process and its going to dominate. The attempts by governments to overrule it are simply insufficient.”

With that in mind, Shilling advises investors to take these steps:

1. Buy Treasury bonds

Economic weakness and the unlikely chance of another Federal Reserve stimulus has investors flocking to safe havens, and U.S. Treasury bonds are still considered safest of all.
Treasury prices are rallying and yields are falling as a result, and Shilling expects that to continue. He’s even comfortable with the riskier long end of the Treasury curve, where investors can make more money as yields decline.
“We like the 30-year [Treasury],” Shilling said. “You get a lot more bang for buck with a decline in interest rates.” For example, if the 30-year bond yield moves to 3% from 4%, an investor stands to pocket a 19% total return, Shilling said.
Of course, Treasury buyers can easily get whipsawed if interest rates march higher, but Shilling is confident that won’t happen anytime soon, especially with the U.S. government now more focused on austerity than stimulus.
“The Fed and the government are pretty much out of ammunition,” Shilling said. “The Fed has tried the printing press — $1.6 trillion in excess reserves and what’s happened? It’s just sitting there. It’s up to the banks and credit worthy borrowers to turn those reserves into money and they haven’t been. It’s the classic pushing on a string.”

2. Bank on the U.S. dollar

Continuing along the safe haven path brings Shilling to a bullish stance on the much-maligned U.S. dollar. It’s a controversial call, but Shilling contends that among the world’s major currencies, the dollar is “the best of a bad lot.”
Of course the weak U.S. economy is problematic for the dollar, but the outlook for the eurozone is worse, Shilling said. He predicts the euro will crack, tumbling to 1.20 to the dollar from about 1.41 now.

3. Bet against commodities

Not surprisingly, Shilling is bearish on commodities. “It’s a market not priced for realities,” he said. Commodity bulls may call the slump in energy and agriculture prices a midcourse correction and contend that China’s continued growth will buoy these markets. Shilling said that line of thinking reminds him of Wile E. Coyote in the Road Runner cartoons, who doesn’t realize he’s run off a cliff until it’s too late.
“The fundamental argument for the commodity bubble, and it is a bubble because so many non-commodity users are involved, is that China is going to buy like there’s no end in sight and continue to do so,” Shilling said. But a global recession and miserly U.S. consumers will take a toll on China’s economy. As China’s growth declines, Shilling said, so will its appetite for commodities.

4. Bet against stocks

When the best offense is a good defense, stock buyers look to companies that pay above-average dividends and operate in sectors that can withstand the worst. Traditional areas include utilities, health care, consumer staples.
Stocks that Shilling said he’d avoid, meanwhile, include shares of homebuilders, automakers and others in the consumer discretionary sector, and banking companies under pressure to delever their balance sheets.
Shilling recommends being short the Standard & Poor’s 500-stock index SPX -1.50% and other broad market bellwethers, along with China stocks and housing-related shares — areas of the market that are overpriced given the heightened prospect for another recession.

5. Sell your house

U.S. housing prices are likely to lose another 20% over the next couple of years, Shilling said. There’s still a huge oversupply of available housing, he added, and a 20% decline would simply bring values in line with their long-term historical trend — and 45% below their 2006 peak. “Sell your house or second home or investment housing property,” Shilling said.
Commercial real estate holds more promise, in contrast. “I like rental apartments and medical office buildings,” Shilling said. “A lot of people cant qualify for mortgages, so they end up in rentals. And house prices can and do fall. A place to live and a great investment are no longer combined in a single family house. Younger families say let’s stay in a rental.”
The aging population and the new health-care law boosts demand for medical office space, Shilling added. Plus, he noted that more physicians are moving out of storefront, street-level space and into office buildings. “This is a growth area,” he said.
One of the few remaining, it seems. The U.S. economic recovery since early 2009 has been two-tiered, Shilling said. Wealthier Americans with stock portfolios enjoyed a rebound, but everyone else felt like the recession hadn’t ended.
What’s changed, Shilling added, is that “the guys at the top” have been affected. “A lot of the people on the top that dominate the security markets talked about a ‘soft patch’” for the economy,” Shilling said. “To them, this was all temporary.”
Now, he said, “the areas that made people all this money and gave them confidence that all this was a soft spot have gone against them.”
The tide has turned, and markets are only beginning to realize it, Shilling points out. As more investors come to terms with this new era of debt-shedding and frugality, money will flow to investments -— mostly defensive ones — that can benefit. It won’t be a pretty transition, but, Shilling said, “There isn’t much you can really do. You just have to wait for this whole thing to work itself out.”