Gary Shilling Gary Shilling.

For the first time in 12 years, economist and money money manager Gary Shilling is recommending that investors short U.S. stocks. More specifically, he’s suggesting a small short position in the S&P 500 while investors continue to hold modest long positions in defensive stocks like consumer staples and utilities, long positions in Treasuries and heavy positions in cash as well as short sales in commodities such as copper.

The last time Shilling recommended shorting the S&P 500 was 2007, just before the Great Recession.

Shilling’s reasons for his current call:  rapidly slowing economic growth in the U.S. and abroad, sliding corporate profit growth and a recent retrenchment in consumer spending and confidence — most of these exacerbated by the continuing U.S.-China trade war.

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Shilling, who says the U.S. economy is already in recession, debunks the idea that low interest rates support high stock price-to-earnings ratios. He argues that the correlation between the S&P 500 P/E and yields on three-month Treasury bills, 10-year notes and 30-year Treasury bond are small and the reverse of what’s expected — less than  50% since 2000 when comparing the S&P earnings yield (the inverse of the S&P P/E) to Treasury yields.

Low yields instead “are probably foretelling economic weakness and possible deflation that will dramatically slash corporate earnings and P/Es,” writes Shilling, in his latest market outlook, noting that business investment is falling, and consumer spending, which supports about 70% of U.S. economic growth, is also slipping. 

In addition, says Shilling, founder of A. Gary Shilling & Co., falling interest rates now are encouraging saving rather than spending by U.S. consumers. The U.S. savings rate is currently just over 8%, below the December 2018 high of 8.8% but well above the 5.9% to 7.2% range that persisted between February 2013 and November 2018.

The jobs report for September, released Friday, didn’t do much to dispel Shilling’s outlook. Wages were unchanged and payroll growth was moderate, at 136,000, though payroll gains for the previous two months were revised higher and the unemployment rate fell to a record low of 3.5%. 

The stock market rallied on the news in the belief that the relatively weak employment report increased odds for another rate cut at the Federal Open Market Committee’s next meeting in October. The latest CME FedWatch tool shows those odds to be close to 80%. The stock market apparently still believes that lower rates support higher stock prices. Shilling doesn’t.

“Evidence of a global recession continues to mount,” writes Shilling. “The remaining piece to assure a U.S. downturn is consumer spending — and payroll and weekly earnings growth continue to slide while consumer confidence as well as income and asset polarization, along with heavy debt, point to further rises in saving at the expense of spending. So do lower interest rates and forced postwar baby spending restraint.” 

(Webinar on Oct. 9: Inheriting the Inheritors: The Big Wealth Transfer and Tools Needed to Capture It)

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