It has been a few months since we last checked in with Gary Shilling, who has been in 'defensive' mode for much of the past 4-5 years (one could say even longer actually). Despite being off on some market calls the past two years, his grasp of the bigger picture fundamental issues has been amongst the best for many years. So I'd concentrate on the economic views rather than specific investing advice. He is still a bond bull, thinking the 10 year could go to an extraordinary 2%.
- “I’m predicting another recession next year,” he (Shilling) told me. Not a double dip, he emphasized, because we’re already two years from the end of the last recession and 3 ½ years from the business cycle’s previous peak, in December 2007. Historically, he said, economic expansions last about three years, especially in long down cycles of the kind he thinks we’ve been in since 2000. So, he’s looking for a brand new cyclical recession beginning in 2012.
- Many Americans will be forgiven if they can’t see the difference between that and the recovery we’ve been experiencing. That’s Shilling’s point. Usually, deep recessions like the one we just lived through are followed by strong snapbacks, like a growth slingshot. This time, however, the recovery has been “distinctly subpar,” in his words. “As of the first quarter, ..real GDP is barely above its peak in the fourth quarter of 2007, whereas earlier recoveries were well above their previous tops 13 quarters later.”Translation: More than three years after the peak, we’re still not back to where we were. There are good reasons for that, beyond the particularly tough toll financial crises take on growth.
- The economy, he says, is like a four-cylinder engine, and a recovery usually requires all four to be firing. They are consumer spending, employment, housing and the reversal of the inventory cycle. Shilling thinks only the last is really recovering — i.e., companies that brutally liquidated inventories during the recession have had to rebuild them through boosting production and some additional hiring as demand bounced off its lows.
- But consumer spending has made only a partial comeback, concentrated among more-affluent buyers. Everyone else has been weighed down by weak job and income growth and the continued housing catastrophe.
- We have seen some improvement in employment, albeit slow of late, and it’s nowhere near what we’ve had in past recoveries. Mostly employers have just stopped laying people off, and when they hire, it’s often on a part-time or temporary basis.
- And then there’s housing. Shilling, of course, isn’t one of the optimists. He’s actually looking for another 20% drop in housing prices before we hit bottom in 2013. Since housing prices nationally already have fallen by a third from their peak, that means that, if he’s right, they’ll end up a stomach-churning 45% off their early 2006 highs. Yale Prof. Robert Shiller, co-creator of the Standard & Poor’s/Case-Shiller Home Price index, has a similar prediction.
- For Shilling, it’s all about inventories: He estimates there are upwards of two million homes on the market that people want to sell but can’t. That’s deflated new-home sales, which now stand at about a third of their normal 1.5 million a year.
- Lenders have foreclosed on 3.5 million American homes since 2007; Shilling expects millions of more foreclosures in the years ahead. If this happens, “you know what that will do to consumer spending,” said Shilling. “That’s a recession — an easy forecast.”
- But slow growth will get politicians of both parties antsy to “do something” in an election year. “If the economy is still weak going into next year, we could have fiscal stimulus,” he told me. Politicians do not “want to face voters with a weak economy,” he said.
- As for investing, Shilling has returned to an old favorite: the 30-year Treasury bond, which is currently yielding around 4.21%. “I think they’re going to 3%,” he said. “I think [the 10-year is] going to 2%.” The 10-year Treasury note was yielding near 3% Wednesday.
- Naturally, Shilling’s not looking for much from equities, and he recommends only blue-chip dividend-paying stocks.
- Shilling’s not infallible, of course. He has been predicting deflation since the late 1980s and in earnest since 1998. We’ve had two potentially deflationary episodes, in 2002 and after the financial crisis, but the Fed was able to dispatch them. He also was very bearish on stocks, expecting new lows in early 2009 and pretty much missed the recent bull market. So, he’s not the guy who’s going to call bottoms or identify bullish inflection points.