Thursday, May 14, 2009

Gary Shilling's Latest Thoughts

Very few people forecast this mess in either magnitude or timing although many now claim they did. Even some of the most prominent "permabears" while correct on many of the outcomes, did not get the investing themes correct (i.e. Peter Schiff)... Gary Shilling is about as close to anyone I can find who not only got the economics right but also made a remarkable set of calls. For example many of us bears thought the dollar would be whipped into submission since in 99 out of 100 cases the country that spawns a world financial crisis does not have all the Earth's money flood into its currency - Shilling got that right, saying to go long the dollar and US bonds (really the only place to hide in 2nd half 2008 as ALL historic correlations broke down). While he was wrong on betting against commodities in 1st half 2008 he made it up in spades in the 2nd half. Unlike a Nouriel Roubini, it is much harder to make both the economic calls and the specific investing calls because the market in the short term is all about sentiment and emotions; logic is useless much of the time - hence I give him even more credence than Roubini. You can see his predictions for 2009 that we highlighted in December here [Dec 21, 2008: More Americans Finding "Fund My Mutual Fund" Blog and Discovering the Truth] Much like I have said, he believes Americans will be FORCED into frugality, kicking and screaming if need be.

I was wondering what he was thinking now, after this magic green shoot rally - so I was pleased to see a new series of videos from Shilling on Yahoo's Tech Ticker. I'd recommend making the 20 minutes to listen to these 3 videos, because unlike most of the hand waving, "I told you to average down even though I cost you 40-60% in 2008" punditry, Shilling has legs to stand on. Granted he missed this monster rally but no one is going to get everything right. I'll be interested to look back in a year and see how these views stand up; I generally agree with much of what he has been saying the past few years from an economic standpoint. Like him, I am sort of chuckling at how people continue to look to all the same people who missed the entire financial fiasco to tell them that the recovery is now at hand.

Shilling Sticks to S&P 600 Target, Despite Pressure to Cave

Back in early March when the market was in freefall, many of the hardcore bears like Doug Kass, Barry Ritholtz and Richard Suttmeier flipped to a bullish view. Not so for Gary Shilling, president of A. Gary Shilling & Co., who stuck with his bearish stance here on March 12.

Fast forward to today: despite a 30%-plus rally off the March lows, Shilling is still sticking with a target of 600 for the S&P 500 in 2009. Shilling concedes the rally has been powerful and that he's getting some "flack" from clients about possibly having missed a major turning point.

"It could be the bottom...but in my view there's enough in the way of problems out there that it probably is a bear market rally," Shilling says, citing the following main reasons why he thinks the economy will remain sluggish and the market will suffer another comeuppance this year:

  • Slowing consumer spending: Today's weaker-than-expected April retail sales report is another reminder of how strapped Americans are in saving vs. spending mode.
  • Financial deleveraging: There was a lot of "financial fluff" in derivatives, Shilling says, but they did help accelerate the so-called velocity of money. The end of the securitization boom means less easy access to credit and less financial activity from consumers and corporations alike.
  • End of the commodity boom: Along with stocks, commodity prices have been rising steadily from the March lows (prior to today, that is). But the end of the speculative fever in commodities is going to mean a lot less spending from emerging markets, he says, most notably in the Persian Gulf.
  • Rise of the Bureaucrats: From higher taxes to the auto industry to today's stories about the Obama administration seeking to control compensation in the banking industry, the government's role in the economy is only increasing. That can't be good for growth, Shilling says, especially as this is a worldwide phenomena.
Three Keys to End the Recession

The "green shoots" theory was looking a little brown around the edges Wednesday as stocks fell sharply following weak April retail sales data and another spike in foreclosures.

Noted bear Gary Shilling, president of A. Gary Shilling & Co., says the recent improvement in economic activity was not a sign the worst has passed but a head fake that's typical in most recessions. There have been positive quarters of GDP growth in 8 of 11 recessions since WW2, and the stock market rallied in sync, Shilling notes.

As for the current cycle, he says three trends have to emerge before it'll be safe to declare the end of the downturn, despite the Fed's efforts to flood the system with money:

  • Housing bottom: A reduction in the excess inventory of homes, which he estimates are approximately 2 million (down from 2.8 million a few months ago but still very high.)
  • A real resolution of the financial crisis: Like John Hussman and others, Shilling isn't convinced the stress tests results proved anything, much less marked the end of the crisis. He's concerned about rising bad loans in sectors outside of residential mortgages, including commercial real estate, auto loans, student loans and credit cards.
  • More stimulus: Shilling estimates Obama's $787 billion package only contained about $200 billion will actually stimulate the economy. With Americans in savings mode, including sitting on recent tax rebates, the government is going to need to do more to "break the cycle of a consumer who is cautious, which means less spending, less production more inventory problems, and more layoffs," he says.

If those three trends turn, then Shilling sees the recession ending in early 2010. That's the potential good news. The bad news is, just like Pimco's Mohamed El-Erian, he's forecasting a "slow recovery" and subpar growth after that for many years to come.

Shilling: Say Goodbye to the Great Gatsby Era of the '80s and '90s

Much like the "Great Gatsby" era of the 1920s, the period from 1982-2000 is going to look like a "marvelous era in retrospect" and in comparison to what's coming next says Gary Shilling, President of A. Gary Shilling & Co.

The "golden era" of growth is over says Shilling, who predicts GDP growth will average 2% over the next 10 years vs. 3.6% from 1982-2000.

"We're going to see a distinct contrast of lower growth," he says. "Not a Depression, not 'recession forever', but muted, lower growth."

Several of the key ingredients of the 1982-2000 era are either not evident presently or are being reversed, he says:

  • Consumer spending: The U.S. savings rate was in the 11-12% range in 1982, and then proceeded to steadily decline into negative territory this decade. The savings rate is now moving back up, which is good for individuals but puts a dampener on overall economic activity.
  • Inflation: Then Fed Chairman Paul Volcker famously "broke the back" of inflation by jacking the fed funds rate to as high as 20% in 1981. Falling inflation and falling interest rates led to higher P/E valuations for stocks. With the fed fund rate currently zero, interest rates only have one way to go - unless they go negative and a deflationary environment isn't good for stocks or the economy either. (Just ask Japan)
  • Era of Big Government: Regardless of your political persuasion it's a fact taxes fell and regulations were reduced in the 1982-2000 era. Now, both trends are being reversed by the Obama administration. While that's what the majority of Americans voted for, Shilling, among many others, believes higher taxes and more regulation will lead to slower growth and a stifling of economic activity.

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