Tuesday, December 1, 2009 4 comments

Gary Shilling maintains his views

In an interview with Robert Huebscher of Advisor Perspectives, one of the true deflationists, Gary Shilling, sticks with his views. In particular, he says the recession may not end until 2010, which is contrary to the consensus view that the recession has already ended. Who knows if he is right since I lean towards deflation, and since Gary's views are contrarian, I pay attention to him.

As he has said in the past, Gary Shilling repeats his view that the US government will likely enact a second major stimulus plan. Again, this is completely opposite most people's thinking. The market not only does not expect this, but believes that there is too much stimulus. I am not too confident with this call but I do think that the second stimulus view is probably correct.

I'm not going to quote much from the interview since most of it has been covered on this blog before; the only thing I wanted to highlight was Gary Shilling's investment suggestions (long only.) The article also mentions some areas to avoid but many of those ideas have been marked down quite a bit already and I think it may be a bit risky. You can read the linked article if you are interested.

Gary Shilling's Long Ideas

Robert Huebscher points that Shilling never went into whether the following assets are overvalued or not so that is something to keep in mind; these are just general ideas without considering present valuations.

(my comments are in square brackets)

Shilling identified nine areas as buy candidates:

1.Dividend-paying stocks. With 2% projected real GDP growth and 2% deflation, Shilling forecasts no nominal GDP growth. Since corporate profits historically correlate with nominal GDP growth, Shilling expects the bulk of equity returns to be in dividends rather than capital gains.

[I am not sold on dividend-oriented stocks. My concern has to do with the fact that they are not contrarian. Just like how everyone was sold on the idea that blindly buying stocks and real estate were the path to retirement—needless to say, these two ended up being two of the worst assets in the last decade—I get the feeling that everyone has been sold on dividend-oriented stocks. This is particularly common with passive investors who appear to be overloaded with them... Another issue I have is that companies once used to pay dividends with cash they didn't need. Nowadays, they try their best to maintain their dividends at all costs, including long-term damage. This was very evident with financial companies, particularly Canadian banks, who were issuing equity and preferred stock at high yields while refusing to cut their common dividends. I am also starting to see companies laying off a lot of workers, cutting R&D and marketing, in order to maintain their dividends.]

2.High-quality bonds, especially Treasury bonds. Shilling forecasts 30-year rates to decline from 4.3% to 3%.

[I have been looking seriously at the long bond. Shilling 4.3% to 3% decline basically implies a potential return of 20% to 30%—but this is spread out over several years.]

3.The dollar. The dollar’s decline will end as its importance as a safe haven increases.

[I have been bullish on the US$ and completely wrong for several years now. This is a very difficult call to make. On the one hand, the US$ should strengthen due to the vaporization of huge quantity of US$-denominated debt; and capital flees from risky regions. On the other hand, US$ should weaken given the American current account deficit. Deflationists obviously lean towards the first view but, if the current account deficit doesn't dissapear, the bullish US$ call is not a given... On a side note, if the US$ starts strengthening, it is likely that gold will get crushed big time.]

4.North American energy. The US and Canadian energy industries will benefit from political stability relative to other parts of the world and from renewable energy policy initiatives.

[I don't share the same view since I am not bullish on energy. Relatively speaking, North American energy is probably better but, overall, I can see someone losing money. If economies of the world remain weak, and if the US$ strengthens, energy or commodities in general are not the place to be.]

5.Consumer staples and food. Deflation and slow growth will not impede consumer purchases of necessities, such as toothpaste.

[I agree but I think this is priced in. Consumer staples appear to be trading at above-market multiples and didn't suffer much during the crash.]

6.Investment advice and asset management. Growth will come because consumers need help with financial advice, provided that fees are commensurate with the value provided.

[I completely disagree with this. My impression is that asset management is strongly correlated with asset performance. Asset managers appear to do well when we have strong bull markets. I suspect that they will do poorly if we are in a bear market or a low-return market. After getting burned badly, I suspect the baby boomers, who basically own most of the wealth (excluding super-rich), will think twice about "creative" investment schemes. I actually expect huge flows into basic assets, like government bonds, which require limited financial advice. I really don't get Shilling's stance.]

7.Factory-built housing and rental apartments. These sectors will benefit as consumers no longer think of housing as an investment.

[no comment... don't know much about real estate, especially factory-built homes]

8.Healthcare. This will benefit from Obama’s initiatives and from its ability to employ people with diverse skills and backgrounds.

[Don't follow healthcare that much but I suspect he is right. On top of this, a lot of the baby boomers, who also hold most of the wealth outside the super-rich, will be ageing and willing to spend on health.]

9.Productivity enhancers. Without inflation pushing up revenues, reducing costs is the way companies will improve profits.

[Yep... covered this before but to reiterate, Shilling believes that companies will pay for productivity gains and has suggested that some technology fields will do well. I have been researching technology companies and haven't found anything but I would like to make a major investment in one.]


4 Response to Gary Shilling maintains his views

December 1, 2009 at 7:02 PM

Regarding nine... what investments have Japanese companies made in their deflationary environment to cut costs? Have these measures of cost cutting made them more efficient over other competitor economies? Cost-cutting of labor seems to be self-defeating as it stifles a major source of aggregate demand contributing to deflation. Maybe capital saving (not labor saving) cost cutting might be a benefit in this deflationary environment. Would this deflationary environment

As for myself... many good investments are investments that people HAVE TO make. In order to get out of the economic crisis, we NEED more growth in science and technology (I see it as the only hope.). We HAVE to invest in science and technology so we can have a brighter future. What investments are essentially long innovation. Peter Thiel says large caps such as Cisco and Microsoft are implict short positions on innovation. Read the link below, Peter Thiel has influenced my views on innovation and science and technology. To me, this crisis is a crisis of science and innovation.


December 1, 2009 at 7:09 PM

I meant to say...

"Would this deflationary environment have the salutary effect of encouraging innovation?"

I am very impressed with Thiel... he is a libertarian, but he doesn't seem to be an avid gold bug. He is a true contrarian. Instead of the circle jerk of gold bugs on Seeking Alpha, and Market Watch, he promotes a true contrarian investment. Long technology... long innovation. It is the bet we have to make!! Longing gold does not produce wealth, but technology does. If technology doesn't work, nothing will.

"<span>Peter recently talked to an LP (endowment) who was thinking of  re-allocating its portfolio to hold less than 5% in venture capital as its recent returns had not matched expectations. Peter told the LP that they’re thinking is flawed: if their 5% allocated to vc eventually does not return a mega profit, the remaining 95% allocation is going to be worthless anyway. ”Investing in technology as a VC is like Pascal’s bet: if that isn’t going to work, nothing will.”</span>"

"<span>Peter slams the NASDAQ explaining that most listed companies are actually not technology companies, rather, they are zero-sum bets against technology (ex: investing in Google is feeding a monopoly on search, Microsoft doing well means linux suffers, etc). NASDAQ companies are more like banks than they are true innovators (Sun may be an exception).</span>"


Sivaram Velauthapillai
December 3, 2009 at 3:56 PM

Aki: "<span>Regarding nine... what investments have Japanese companies made in their deflationary environment to cut costs? Have these measures of cost cutting made them more efficient over other competitor economies? Cost-cutting of labor seems to be self-defeating as it stifles a major source of aggregate demand contributing to deflation."</span>
<span>Are you Japanese? Do you live in Japan? If you do, I'm curious on you perceptions about what has been happening over the last decade. Anyway...</span>
<span>My impression is that Japanese companies have been spending money on technology and processes over the decade to improve efficiency. For instance, Japanese car companies seem to be far more automated than anyone else. </span>
<span>However, as you mentioned, such moves hurt consumer demand. You either end up with layoffs (Japan has chosen not to pursue this) or flat to negative employee earnings.</span>
<span>Aki: "Maybe capital saving (not labor saving) cost cutting might be a benefit in this deflationary environment."</span>
<span>I would argue that there is no such thing as "capital saving." Or even if there, I suspect that is the least of the worries during deflation. Although deflation destroys a lot of capital, my impression is that there is always excess capital--a capital glut if you will. For instance, returns on capital or cost of financing in Japan is really low. Some might argue this is because of the central bank but it really isn't. The free market is setting rates really low (the P/Es are so high and companies are sitting on huge piles of cash on their balance sheet.)</span>

Sivaram Velauthapillai
December 3, 2009 at 4:05 PM

This is the first time I have encountered Peter Thiel (I may be run across some news story or article in the past but haven't read anything detailed by him until you linked to those stories.)

I don't necessarily share his thinking. I also think he is incorrect in suggesting that Microsoft, Google, et al are a short position against innovation. Let me address this in a standalone post.

Post a Comment