Gary Shilling's thoughts on the next decade

I lean towards deflation, although I don't expect outright deflation* in a country like USA, so I always pay attention to one of the few deflationists around: Gary Shilling. Writing for MarketWatch, Paul Farrell, summarizes Gary Shilling's thoughts in his new book, The Age of Deleveraging. I haven't read any of Shilling's books but I do plan to get to them eventually—at the rate I'm going, it might take 249 years ;)

Shilling has been somewhat of a deflationist for almost a decade and his call in the late 90's turned out to be wrong. Needless to say, no one can predict the future precisely. However, some of his correct calls were very significant calls, such as the bullish call on US Treasuries in the 80's.

With that said, you will find below a Farrell's summary of Shilling's key calls. Most of the calls are similar to what Shilling has said in the past and as should be expected with a deflationist, it goes against the consensus (big time!). As is usual, my comments are in square brackets.

Twelve Sells for the Next Decade

• Sell banks and similar financial institutions [goes against many value investors who are overloading on these right now]
• Sell credit-card and other consumer lenders [goes against value investors betting heavily on these]
• Sell conventional home builders and suppliers [goes against Warren Buffett who implied housing is near bottom]
• Sell commercial real estate
• Sell commodities [one of the potential areas for huge losses is commodities]
• Sell junk securities
• Sell flailing companies - “Companies with below-average revenue growth, high-fixed costs and big debts represent a lethal combination in an era of slow growth and deflation …the only route to profit gains or even stability is cost-cutting.”
• Sell big-ticket consumer purchases
• Sell low- and old-tech capital-equipment producers
• Sell antiques, art and other tangibles
• Sell developing-country stocks and bonds [the other big area for potentially huge losses lies in developing markets, which have not really corrected much in the last 10 to 12 years]
• Sell Japan - A slow train wreck. Back in his 1988 book, “After the Crash,” Shilling compared Japan’s exuberance to America’s “Roaring Twenties,” predicted they’d drop into a 1930s-type of depression. Looking to the future: “Japan’s aging and declining population and troubled export outlook may finally be catching up with it,” and the yen will continue to weaken. [this is an interesting call... I have looked hard at Japan but I can't come to any satisfactory conclusion, either way]

Now for some bullish calls...

Ten Buys for the Next Decade

• Buy income-producing securities - Stock market’s gone nowhere for 12 years, says Shilling. Pick selective income-producers: utilities, drugs, telecoms, high-grade munis, preferreds, etc. [I don't like this strategy because it is a consensus view. Almost everyone is saying this but these people have been saying the same thing for the last 30 years—and have been right! Therefore, as a contrarian, I would be wary of income-oriented strategies. Yes, they should do well in deflationary-like scenarios but I have a feeling that a lot of companies can't sustain their dividends or bond coupons.]
• Buy American energy sources [Weird call given how he is bearish on commodities, although it's not clear if Shilling is bearish on oil & gas. The market is already pricing American (Canadian or Australian) energy companies with a safety premium so it's hard to see how you can outperform with them—unless we end up with a physical war or trade war that cuts off foreign supplies. I would not bet on this strategy.]
• Buy factory-built housing and rental apartments
• Buy health care [I don't share the same view. Although a big upside may exist, I would be nervous given how healthcare spending in most developed countries is totally out of control and unsustainable.]
• Buy the U.S. dollar [Agreed]
• Buy Treasurys and other high-quality bonds [Treasuries aren't as attractive now, unless you buy on a dip. However, high quality corporate bonds are attractive as long as inflation stays low.]
• Buy food and other consumer staples [upside low...but downside is low too]
• Buy productivity enhancers - “Anything — high tech, low tech, no tech — that helps customers reduce costs and promote productivity will be in demand.” [This is probably one areas where there is a lot of opportunity. The market, since it is tilting towards inflation, likely hasn't run up the values of such companies. If we do end up with GDP growth around 2% and inflation around 0% to 1%, I can see these companies entering a secular bull market. Having said all this, I have no idea which companies would fit the criteria. I have spent some time thinking about this, ever since I heard Shilling say it an year or two ago, but it's hard to identify these companies.]
• Buy small luxuries - Yes, frugality’s in, discounts, house brands. But still, we all have that special something. Shilling calls it “cheap chic:” You treat yourself with favorite chocolates, wine, cigars. [I don't know about this. It sort of makes sense but finding these companies is not as easy as it seems.]
• Buy investment advisers and financial planners - “Low investment returns will discourage do-it-yourself investing and encourage the use of professionals.” [oh...this is a unique call for a deflationist. Many deflationists, including me, think returns on investment are going to be low and hence people and institutions will not pursue investment returns as much. That is, people will still invest but they may invest in US Treasuries or high-quality corporate bonds, rather than shares or commodities or whatever. If anything, I think people will back away from financial planners and move towards passive investing. I don't know; that's what I'm thinking. Shilling clearly doesn't share my feeling.]

So there you have it. Unique perspectives from an interesting fellow.



Footnote:

* Outright deflation without a hard currency is almost impossible. You may get a few years of negative price changes but I don't think there has been a case of negative price changes for a decade or longer. For instance, Japan is considered the classic deflation case yet price change were mostly positive. The (monthly) average since 1990 is actually a near-zero, slightly positive, rate. The following chart from Trading Economics illustrates the monthly CPI in Japan since 1990 (the orange bar on the right indicates range, max, min, and mean).

Having said all that, the GDP deflator in Japan (not shown) has clearly stayed below zero for most of the time. Some, such as Alan Greenspan, believe that the GDP deflator is a better measure of inflation than the CPI so it all depends on your beliefs