July 9, 2012

Risk On or Risk Off? Goldman’s Jim O’Neill vs. Gary Shilling

Market bull O’Neill sees promise in S&P 500 while Shilling sees a lousy Q2 and years of deleveraging

Lighten up, people. The situation is not as bad as you think.

Jim O'Neill, chairman, Goldman Sachs Asset ManagementSo says market bull Goldman Sachs Asset Management Chairman Jim O’Neill (left) in a “Markets and Moods” viewpoint written last Friday just before the U.S. Labor Department released its June jobs report. While acknowledging that the mood has been grim and the market bearish, much of that mood has centered on a sense of hopelessness about Europe, “with the risk on/risk off mentality seemingly suggesting that it is impossible to differentiate markets as an investor,” O’Neill writes.

Money manager Gary Shilling begs to differ, saying that until U.S. and European consumers recover, he'll continue to be a market bear.

And yet, O'Neill notes, prior to the U.S. jobs report the S&P was up 8.75%, the DAX German stock index was up more than 10%, the Nikkei was up 6.7% and the Chinese Hang Seng index was up 7.4%.

“Even India is up over 13%. Yes, Italy and Spain are down year to date, but not everyone else’s markets are,” writes O’Neill, who made his fame as the man who coined the term “BRIC,” in reference to the economies of Brazil, Russia, India and China. “A superficial conclusion might be that markets, as wrong as they sometimes can be, yet again, are more on the ball than many that talk about them.”

O’Neill says he’s particularly intrigued to see the Indian equity market as the strongest of the BRIC country markets, “despite the fact that many people, me included, would have more concerns about the Indian economy and policy than the other BRIC countries.”

He suggests that India is outperforming because oil prices have dropped, the markets are expecting a major shift in policies to finally endorse foreign direct investment and, not least important, global investors may simply have become too gloomy about India.

O’Neill on China vs. India

Looking at China vs. India, O’Neill asserts that the debate is unfairly weighted to favor China.

“It is true that they both share the fact they have more than 1 billion people. But other than that, there are huge differences,” O’Neill writes. “China’s economy was around $7.3 trillion by the end of 2011 and India’s was around $1.7 trillion. As a result, Chinese citizens are on average around three times wealthier than their Indian counterparts.”

In a tip-off to investors, O’Neill also suggests that China’s disappointingly flat performance so far this year provides a good argument that “the only way to pro-actively invest for the China (and in the widest context, broad emerging equities) story is to invest through the best global companies and most exposed global developed markets.”

Shilling’s Bearish Thoughts

After such bullish market talk, thoughts from a bear are in order, so AdvisorOne called money manager and economist Gary Shilling for his thoughts.

While agreeing with O’Neill that in the long run he would bet on India over China – “it’s a democracy, with a British legal system, they don’t have a one-child policy so they have younger people coming on and they aren’t export-driven to the extent that China is” – Shilling said his overall view differs with the Goldman chief’s precisely because developing countries are so export driven.

Gary Shilling“That’s the big difference that I have with his view,” said Shilling (left). “Because when he talks about growth of the BRICs and developing countries in general, and why they aren’t appreciated in the stock markets, I think the real reason is that those countries are export driven, and the buyers of those exports, which are Europe and the U.S. consumers, are no longer there.”

As for his outlook on the U.S., Shilling pointed out that the S&P 500 is back below 8.75% once again. More importantly, he doesn’t see the U.S. consumer bouncing back anytime soon.

“I think we’re going to see disappointments with second-quarter earnings,” Shilling said. “U.S. corporations have run out of the ability to cut costs and take it to the bottom line. Corporate profit share of national income hit an all-time high in the fourth quarter as a result of cuts. Of course the flip side of this is that if you’re firing and not hiring, then people aren’t making money, so how do they buy the goods that they’re helping to produce? They did it by reducing their savings rate, but now it looks like consumers are reversing gears and have a long-term incentive to save, and rebuild assets and pay down debt.”

Sorry, Mr. O’Neill, but Mr. Shilling says we’re probably in a recession in a risk-on world. “We’re about five years into the deleveraging, and at the rate we’re going, it will take another five to seven years to complete,” he said.

Read S&P 500 Will Drop 43%: Shilling at AdvisorOne.

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