Gary Shilling knows a thing or two because he’s seen a thing or two, to paraphrase a current TV commercial. Indeed, seeing things that other economists fail to perceive has been the secret to Shilling’s accurate economic and market forecasts for more than 50 years now.
Going beyond the consensus view that’s been priced into markets, he looks for “strange” and “exotic” indicators not expected by most observers, Shilling tells ThinkAdvisor, in a wide-ranging interview.
This year, the biggest threat to the market is complacency, he argues, and deflation — falling prices — could be just around the bend. That’ll be no surprise to Shilling: In late 2010, he released the bestselling “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation” (John Wiley).
For the rest of 2017, he looks for flat GDP growth, of about 2%, because President Donald Trump’s promised fiscal stimulus, once in place, has little chance of becoming effective for another two to three years thereafter, he says.
Shilling, 80, president of A. Gary Shilling & Co., an economic consultancy and investment advisory firm, is famed for forecasting market bubbles and pinpointing when they’ll burst. Among other events, he forecast the 1960 and 1991 recessions; the end of a long stretch of severe 1970s inflation; and in 2003, that the Federal Reserve would cut short-term interest rates the following year.
He started out as a physicist, then switched careers to financial services, working at the Federal Reserve Bank of San Francisco and Bank of America. He was Merrill Lynch’s first chief economist and later, senior vice president-chief economist of White Weld & Co. Thirty-nine years ago, he launched his own firm.
ThinkAdvisor recently interviewed the Bloomberg View columnist, on the phone from his office in Short Hills, New Jersey. Shilling declared the Fed to be “completely clueless”; discussed the future of passive investing and robo-advisors; and opined that Trump is “impeding his ability to get much done in Washington.” Here are excerpts from our conversation:
THINKADVISOR: What’s the biggest threat to the stock market this year?
GARY SHILLING: Overconfidence and complacency. The VIX [Index] has just hit an all-time low. But [people are], “What, me worry?” Another thing is that a very limited list of stocks has accounted for a lot of the advance. It reminds me of the “Nifty Fifty” of the early 70s: You only buy; you never sell. It got to the point that the only thing people wanted to buy was amusement parks, motor homes and cameras. That was entertainment, not the guts of the economy.
How does this relate to what’s happening now?
Social media is entertainment, at best. It doesn’t have a lot to do with what I consider the basic economy. It shows you that people aren’t interested in the fundamental assets of things.
You’ve spotted bubbles and predicted their death. Do you see a bubble in the market today?
I don’t see any huge ones right now. The exuberance in stocks is overdone, but it isn’t anything like the dot-com nonsense of the late 90s or the subprime mortgage exuberance in the mid-2000s. Maybe it will get there, but it’s not quite yet at that level.
I suppose there’s also the possibility of a geopolitical event to jolt the market.
That’s true. We might have a shock out there. If we get another big decrease in oil prices, that could constitute a shock, or if something financial blows up in China, or if there’s all-out war in the Middle East.
What does history say about recoveries?
In modern history, economic expansion ends when the Fed, worrying about an overheated economy, jacks up interest rates or when there’s a shock, which is what happened at the end of the 1990s: the collapse of the dot-com stocks and then the debacle in subprime mortgages.
What’s your outlook for the bond market?
Despite the Fed’s raising rates and now their talk about selling off their portfolio, bonds have done beautifully. They’ve actually rallied. One reason is the economy isn’t that strong. Secondly, deflation is more likely than inflation. There are some tremendous deflationary forces. Goods are in deflation, and so are [some services], like financial services.
What else is in play related to bonds?
Look at what online retailing is doing to brick-and-mortar stores. The third thing is the safe haven of the dollar, one of the few in a sea of global trouble. The final reason is U.S. Treasury yields: as low as they are, they’re still much higher than in most other developed countries.
You mentioned the possibility of the Fed’s selling the Treasuries and mortgage-backed securities it bought. Would that cause a recession?
[Selling those] is a very difficult maneuver. We’ve never had quantitative easing in the history of the Fed or any other central bank before. The Fed has had over a century’s experience trying to regulate the economy with interest rates, and they’ve failed miserably at affecting soft landings. By my reckoning, in the post-World War II period, they’ve tried 12 times to mitigate what they saw as an overheating economy without precipitating a recession.
And what happened?
In 11 of the 12 times, they failed and got a recession. The only soft landing was in the mid-90s. Trying to unwind quantitative easing, with which they’ve had no experience, and given their track record with interest rates, what are the odds that they’ll be able to reduce that portfolio substantially without upsetting the financial apple cart? I’d say they’re very, very small.
What do you predict for GDP growth this year?
In 2010, I forecast 2% real GDP growth until all the deleveraging and effects of globalization have been worked off. So far in this recovery, which started in the middle of ‘09, growth has been [at] 2.1%. I think that will continue until we get this massive fiscal stimulus in place. But it will probably be two or three years down the road before it really becomes effective.
That’s quite a while. People had been dissatisfied with the rate of recovery for a long time.
Yes. I don’t think the Fed realizes the kind of environment we’re in. They think we’re in a typical postwar cycle, so they’re worrying about inflation and overheating the economy. Well, inflation is receding. Economic growth is low, if not declining. Interest rates are declining.
So you’re saying the Fed isn’t facing the reality of the situation?
I think these guys are way off the mark in terms of what’s going on. They keep wondering why the economy doesn’t pick up growth and why inflation doesn’t pick up. I think they’re completely clueless.
What’s the main thing indicating we’re not in a typical postwar cycle?
We’re in this huge deleveraging, still working off a lot of the excesses built up in the ’80s and ’90s and the mid-2000s that culminated in the big subprime housing bubble and collapse.
The Fed seems to be giving mixed signals. First it said it would increase interest rates rather aggressively, but now that doesn’t seem to be the plan. Doesn’t that confuse investors?
Yes. The Fed’s credibility is very low. In fact, I think the only reason they finally raised interest rates in December 2015 was because they wanted to save face. They were becoming a laughing stock.
President Trump hasn’t been able to deliver on his campaign promises. Are you surprised?
Last December, I said that the huge fiscal stimulus — deregulation, tax cuts, replacement for Obamacare — wasn’t going to happen instantly. It takes lot of time to get [things] through Congress; and even though it has a majority of Republicans, Trump doesn’t have Congress in his pocket. I think he’s making things more difficult.
Will his base continue to be loyal to him while waiting for the stimulus?
They’re going to be loyal to the voters. It’s only the top tier that’s had any gains in over a decade, and [other] people’s attitude was “I’m mad as hell, and I’m not gonna take it anymore!” There’s been a decline in purchasing power for most.
What’s most likely to get pushed through first?
One thing I do think is going to happen is fiscal stimulus in the form of infrastructure spending and increased military outlays because they’re pretty solidly backed on both sides of the aisle. But some other things, like massive tax reform and deregulation, are very much more problematic.
Where will funding for infrastructure spending and the rest of the fiscal stimulus come from?
That doesn’t become an issue, really. The shock and awe over the $1.5 trillion federal budget deficit is gone; and at the same time, we have this pressure to get the economy rolling. Monetary policy has proved to be impotent in terms of rekindling the economy. So it’s really up to the fiscal side.
How long will it take for any of the stimulus to come through?
Even if [the government] started today on big infrastructure projects, by the time they pass it through Congress and then go to the states, where the money gets spent for highways and bridges, it will be [quite a while]. The same is true of military spending. It takes time to design a new program.
All of that is disappointing.
The challenge for politicians who want to get re-elected is to figure out a way to convince the public that they’ve taken action and are doing something, that things are on the way. In other words, “Don’t worry, it will be here soon.”
That seems like a big challenge.
But it’s what F.D.R. did. When he took office in 1933, it was the bottom of the Depression. He came in with all the New Deal programs, but none of them amounted to anything for two or three years. [In the interim], he did a masterful job of selling people: “We’re here for you. Help is on the way.” That’s the kind of PR program we’re going to see mounted now.
Do you think Trump is contributing to some of the confusion and anxiety people feel?
Oh, sure. But that’s part of his act, his charm. It’s a drawback. But bear in mind, he ran as an outsider. Most Republicans said some very embarrassing things about the guy that turned out to be the next president. But he came into Washington saying “I’m representing all the people who’ve had declining real income over decades.” That’s what put him in power and created the whole populist movement.
He still seems very much like Candidate Trump.
I guess you would have assumed that once he got in, a lot of his campaign rhetoric would disappear and he’d calm down a bit. But he hasn’t, and it certainly hasn’t done him much good to constantly keep [folks] stirred up. It’s certainly impeded his ability to get much done in Washington.
We’ve never had a president that operates the way Trump does.
Oh, we have, we have. Look at Andrew Jackson. The 1828 election between John Quincy Adams and Andrew Jackson was unbelievably acrimonious. Jackson was accusing Adams of being a pimp — selling favors to Russia. The Adams people raised the question as to whether Jackson’s wife was pregnant before they were married. So what’s going on today is relatively tame. Oh yes, American history is replete with some real characters.
On what do you base your economic and market forecasts: your intelligence and perspicacity, history, math, some “X” factor?
It’s a combination of all those things — judgment, experience, history. The idea of a surefire formula for forecasting markets and economic functions is self-defeating. There’s no such thing as a formula that’s going to work for any length of time because applying it will change the environment in unpredictable ways, and it will no longer work.
Let’s say you had a surefire formula for forecasting stocks, and you’re making untold zillions. It would be pretty hard to keep that secret. Word gets out — and what happens? Everybody else applies the same formula and in doing so, changes the universe to which the formula applied. So it no longer works.
You’ve noted that you’ve been “challenging the consensus since 1981.” What are some other things you discern now that haven’t been discounted?
Certainly, with declining Treasury yields, the driving factor is disinflation. Now I think you may see actual deflation. [Also], I’ve been very bearish on commodity prices. If you look at inflation-adjusted commodity prices going back to the middle of the 1980s, they’ve been in steady decline. Periodically, people say there’s a shortage of copper, iron ore or oil, and prices are going to go through the roof permanently. But they never have. Human ingenuity beats shortages any day, always has and always will.
What else guides your forecasts?
I’m a firm believer in history. Human nature changes very slowly over time, if at all. So in similar circumstances, people react in similar ways. But it’s still an art, not a science.
Do you ever not challenge the consensus?
In this business, you don’t add any value by rehashing the consensus. It’s really a matter of finding things that are new, very strange and exotic and outside the view of the consensus. Things that are quite different from what the consensus expects are where you can really make a mark.
But you don’t always take a contrary position, do you?
If I see the same thing the consensus does in a particular area, I pass it over lightly. But if it’s something that’s important that has a good chance of happening and is not yet within the purview of the consensus, I come on with all fours.
What do you predict for robo-advisors?
I don’t have the exact blueprint for what’s going to happen there, but I think the whole thing is overdone. When everybody becomes so convinced that you can’t lose in one approach, that’s the time you get suspicious that something is going to cause its demise and you’d better start looking carefully.
You think that’s the case with robos?
I’ve had that feeling with robo investing, and passive investing versus active investing. You’ve had this huge rush into passive management and now robo investing, which is a sort of cousin.
Turning from computer science to natural science, are you still a beekeeper?
Very, very much so. I have about 100 hives. It’s a vastly overgrown hobby. In early August, we’ll be taking off the honey. So we’ll be out there with all those girls. I hope they’re friendly — they don’t always behave.
Girls? You mean queen bees?
No. The females. There are three castes: the queen, who can lay eggs and reproduce. The drones are the males. They can’t sting, and they don’t work. The only thing they do is mate with the queen. The worker bees are the females. They do all the work.
Oh, that’s quite interesting …
Women always enjoy hearing me say that.
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