Gary Shilling is Bearish on Housing

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Gary Shilling’s Bearishness Doesn’t Seem Nutty

The recession will now turn deeper and the Federal Reserve is worried about deflation.

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Gary Shilling says, House Prices Still Have Another 10%- 20% To Fall

A year ago, house prices finally stopped collapsing after two years of brutal declines. Over the following few quarters, moreover, they actually rose. This led many observers to conclude that the housing bottom had been reached and that we were headed for a v-shaped bounce.Not Gary Shilling.Gary Shilling, head of economic research firm A. Gary Shilling & Co., thinks house prices still have another 10%-20% to fall. Just as bad, Gary thinks this fall will happen over the next three years, meaning that house prices won’t bottom until 2013. Most people think prices have already bottomed, or will bottom later this year or next.Why is Gary so bearish?Supply versus demand.Basically, Gary says, we still have way too many houses relative to the number of people who want to buy them. Consumers are under pressure, overloaded with debts and struggling to find work, and the mass-hallucination that investing in housing was a “sure thing” is now a distant memory. These days, many would-be home buyers are moving in with relatives or downsizing or dumping second homes. And the supply-demand balance is so out of whack, in Gary’s view, that even super-low interest rates won’t keep prices afloat.

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Gary Shilling: Higher Government Pay Will “Likely Lead to a Tax Revolt”

14.8 million Americans are currently out of work and looking for a job, according to a report released today by the Bureaus of Labor Statistics. Even if you do have a job, wages have not increased substantially over the last ten years, with one exception: government workers.Thanks to generous health-care benefits and pensions, it pays – more than ever – to work in the public sector. Economist Gary Shilling fears dubious consequences if state and local workers continue to make more money and at the same time governments raise taxes and cut services.”In good times, nobody really cares that much but now we’re not in good times,” says the President of A. Gary Shilling & Co. “The basic problem is pay differential, as I see it, and that I think is likely to lead to a taxpayer revolt.”Shilling’s point about pay is illustrated well in this recent research by Dr. Mark J. Perry, professor of economics and finance in the School of Management at the Flint campus of the University of Michigan.According to a December report from the BLS, state and local government employers spent an average of $39.83 per hour worked ($26.24 for wages and $13.60 for benefits) for total employee compensation in September 2009. Total employer compensation costs for private industry workers averaged $27.49 per hour ($19.45 for wages and $8.05 for benefits). In other words, government employees make 45% more on average than private sector employees.According to another BLS report, compensation for private industry workers has increased by 6.9% between December 2006 and December 2009, compared to a 9.8% increase for government workers (state and local) over the same period.If that’s not enough, the trend will lead to a lowering of our standard of living, even for the highest paid workers on Wall Street, Shilling tells Henry in the accompanying clip. If reforms like the Volcker Rule take hold, Shilling’s “not sure Wall Street (will be) permanently bidding up the prices of Manhattan real estate and vacation homes in the Hamptons.”

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40%-50% Chance Stocks Will Crash To New Low, Says Gary Shilling

Last summer, our guest Gary Shilling of A. Gary Shilling & Co. predicted that stocks would fall 30%.  That hasn’t happened yet, but the extraordinary bull run that made idiots out of many of Wall Street’s greatest gurus last year has now finally reversed, and Gary is sticking by his bearish guns.

At Dow 10,000, Gary says, stocks are still priced to reflect a strong economic recovery throughout 2010 and 2011.  And that’s not going to happen.  Consumers still account for more than 70% of the spending in the U.S. economy, and consumers are retrenching.  The value of their assets has plummeted, so they’re finally saving again.  They’re unemployed.  They’re tapped out.  Put all that together, and consumer spending will continue to be weak, and the overall economy will only grow 2% a year.

When the market finally realizes that its dream of a v-shaped recovery is too optimistic, stocks will go lower–perhaps much lower.  In fact, Gary thinks there’s a 40%-50% chance they’ll crash right through the bear-market lows set last spring.

So what’s an investor to do?

Buy Treasury bonds, Gary says.  Contrary to the concerns of they hyper-inflation crowd, the world is awash in excess capacity.  We have too much production capacity, too many houses, too much labor.  Overcapacity leads to deflation, not inflation.  So today’s 4.5% long-term Treasury yield will go to 3%, making bondholders 25% in the process.

And buy the dollar.  At the end of last year, everyone agreed that the dollar was going to continue to collapse.  That was your queue to get the heck out.  It’s not that we don’t have serious problems with deficits and debt in the U.S., Gary says–it’s that our problems are less bad than the problems facing the Euro.  Gary thinks the dollar will rise back to parity with the Euro, a major move from the ~$1.35 it takes to buy a Euro today.

And sell commodities.  China is overheating, and as it corrects, it will take global commodity demand down with it.

In short, Gary says, do exactly the opposite of what everyone was telling you to do at the end of last year.

You Have 3 Choices: Inflation, Deflation, or Stagflation

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There are 3 possible scenarios for the U.S. economy.

Stay alert
Invest accordingly

Deflation

Deflation is the threat dominating headlines. “You’ve got a strong supply of goods and weak demand. That’s a recipe for prolonged deflation,” says A. Gary Shilling, economist and author of Deflation: How to Survive & Thrive in the Coming Wave of Deflation (McGraw-Hill). The problem is deflation’s ripple effect: When banks stop lending, businesses stop expanding and wages fall. Consumers stop spending, which pushes prices lower. Why won’t massive stimulus pull the economy out of the deflationary lane? Shilling fears that the U.S. government’s economic tampering will have a “Big Brother effect,” hurting innovation and permanently curbing growth.

The Signs. The surest sign of deflation is a decline in the consumer price index, which tracks the prices of consumer goods and services. But it’s hard to ignore lower real estate values, which aren’t in the CPI. Home prices fell more than 18% in 2008, according to the S&P/Case-Schiller U.S. National Home Price Index. Another deflation indicator: the higher savings rate, which we’re seeing for the first time in 25 years. Shilling expects the savings rate to rise from 4.2% to 10% in the next decade.

Investment Strategy. “Quality is paramount in deflationary markets,” Shilling says. He thinks most investors should be in short-term certificates of deposit or money-market funds. Those with a 10-year time horizon should also buy tech stocks, such as semiconductors, he says. Companies facing deflation can’t cut prices and must boost productivity through technology.

Inflation

The Argument. Many of the economists and financial advisers polled by BusinessWeek for this story believe the huge amount of money being pumped into banks by the Federal Reserve (chart, right) makes inflation a real threat. Hans Olsen, chief investment officer for JPMorgan Chase (JPM)’s private wealth management business, says the stimulus plan ultimately will lead to higher inflation. However, total inflation is basically nonexistent at -0.4%. The trick is figuring out when it will be a problem. “The nasty thing about inflation is that it’s insidious,” Olsen says. Banishing inflation from the economy once it is “infected” is hard.

The Signs. The leading indicator used to measure inflation is the CPI.

Commodity prices, particularly those of oil and copper, are another bellwether. One indicator Olsen tracks is government debt as a percentage of gross domestic product, which he sees surging from 40% to 80% over the next few years.

Investment Strategy. Mild price inflation is considered healthy for stock investors because it is a sign that the economy is growing. But when inflation spikes, as it did when it hit 13% in the 1970s, interest rates rise and borrowing stops. For bondholders, soaring inflation eats away at asset values over extended periods.

The most direct way to fight this is to buy Treasury Inflation-Protected Securities (TIPS)—government-backed bonds pegged to inflation via the CPI. (TIPS belong in tax-deferred accounts because they are not tax-efficient.) A study by economic consultancy Peter L. Bernstein Inc. found that, for an aggressive investor who is worried about inflation, a 47%/53% proportion of TIPs to stocks (the study tracked broad stock market indexes) provided the best risk-adjusted real returns over a wide range of inflationary environments.

Among mutual funds, advisers favor the Vanguard Inflation-Protected Securities Fund (VIPSX), which had an annualized return of 5% for the past three years. Other plays include the iShares Barclays TIPS Bond exchange-traded fund (TIP) and Pimco Real Return Fund (PRTNX).

Commodities are another classic hedge. A well-diversified commodity play is the Pimco Commodity Real Return Fund (CRIX), which combines commodities with TIPS. Many advisers also like the SPDR Gold Trust ETF (GLD) and the First Eagle Gold Fund.

Stagflation

Stagflation is caused by the combination of slow growth and surging inflation. Slower growth will come from extreme caution by lenders, households, and businesses, while a shortage of production capacity will create inflationary bottlenecks, argues Mohamed El-Erian, chief executive officer at Pimco. “Stagflation will be part of the new normal,” he says.

The Signs. The misery index, which combines the unemployment and inflation rates, is the best gauge of stagflation. In March it was at 8.1%. El-Erian predicts that unemployment will hit 10% by yearend, and 2% inflation could bring the misery index up to 12% by the end of 2010.

Investment Strategy. Insulating your portfolio from stagflation is tough. Equity investors need to take a very conservative stance, focusing on high-quality growth stocks such as Johnson & Johnson (JNJ) and PepsiCo (PEP), says John Boland, financial adviser at Maple Capital Management. Gold, as well as TIPS, will help mitigate some of the inflation risk. El-Erian considers TIPS a bargain because 10-year TIPS are pricing in inflation of less than 1.5% for the next decade, and he sees inflation jumping as high as 6% by 2011.

yahoo-finance Young is a Personal Business editor for BusinessWeek with Tara Kalwarski in New York

S&P predicted to Fall by 30%: That’s Gary Shilling’s Forecast

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Posted Dec 19, 2008 12:33pm EST by Aaron Task in Investing, Commodities, Recession

The S&P 500 could fall to as low as 600 in 2009 and “alternative assets” like commodities and currencies will provide no shelter for investors, says Gary Shilling, president of A. Gary Shilling & Co.

Having been appropriately bearish heading into this year, Shilling sees “few good places to hide” in 2009. Currently, Shilling is long Treasuries and the dollar, but notes the bond market’s rally is getting long in the tooth.

Other than defensive plays like utilities and consumer staples, Shilling is short stocks. His “S&P 600” prediction, a 33% drop from current levels, is based on a view that S&P earnings will be $40 per share next year (vs. the consensus of $83) and the index will trade with a P/E multiple of 15. (Here’s the math: $40 EPS x 15 P/E = 600.)

Shilling is also short commodities and remains bearish on emerging markets, most notably China. The theory China, most notably, could “decouple” from the U.S. doesn’t hold up to scrutiny, Shilling says, as evinced by the slowdown of China’s economy and the fact their middle class isn’t large enough to sustain growth internally.

Against that backdrop, Shilling isn’t only bearish on China as an investment, he sees the potential for major social upheaval in the world’s most populous nation.