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Gary Shilling: 6 Signs the Economy Is Weaker Than Investors Think

By Dinah Wisenberg Brin

Slideshow December 09, 2022 at 04:40 PM Share & Print

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Related: 10 of Jeffrey Gundlach’s Economic, Market Predictions for 2023

Economist A. Gary Shilling, sticking by his bearish view that the S&P 500 index will likely fall another 20% before hitting its low, suggested Thursday that the U.S. economy is already enduring a drawn-out recession and is weaker than many people want to admit.

The investment advisor also said during a webcast that he doesn’t expect the Federal Reserve to reverse its tightening cycle anytime soon.

He suggested the money that the Fed pumped into the economy during the pandemic went into “various investments including all these speculations and what we’ve seen was a tremendous runup and now complete disasters.”

Calling FTX’s collapse a “spectacular disaster,” Shilling said “it really does show what happens when investors get carried away.”

Shilling noted that non-publicly traded real estate investment trust withdrawals are up significantly.

“You can see that people are just running for the exits. In other words a lot of these things that attracted people earlier are really just disintegrating,” he said.

Check out the gallery for six signs the worst may be yet to come, according to Shilling.

Dinah Wisenberg Brin

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1. Stock investors haven't reached the ‘puke point.’

“There has been a constant hope by many investors, bulls certainly, that this was only temporary, that this isn’t a really deep bear market even though it’s been down over 20%, which is sort of the informal definition of a bear market, and that there isn’t a recession,” Shilling said.

The market needs to reach the “puke point,” where investors want to regurgitate their last equity and never buy another one, he said. “That's what happens at serious market bottoms and I just don’t think we’re there by any stretch of the imagination.”

Shilling believes the S&P 500 is about halfway to his predicted 40% peak-to-trough decline in this market. The long-term average S&P 500 stock price relative to inflation-adjusted earnings over the previous 10 years — going back more than a century — suggests an even steeper decline, he noted.

Investors haven’t really accepted the idea that the Fed is serious about killing inflation, that its actions will further damage the stock market and there will be a recession, Shilling said, noting that whenever shareholders get enthusiastic the Fed comes in and dashes their hopes that rate hikes will end soon.

“We’re a long way from the bottom on this,” he said.

(Image: Shutterstock)

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2. The U.S. is likely in a recession now.

A recent Federal Reserve Bank of Philadelphia survey shows that professional forecasters predict a nearly 50% chance that real gross domestic product will contract in any quarter next year. Shilling suggested the economy is there already.

“I think we’re probably already in a recession,” he said, noting that the National Bureau of Economic Research, the organization that formally delineates recessions, often makes that call well into or after a downturn based on various data points. Shilling speculated the recession started roughly in the middle of this year and expects it will persist until mid-2023.

The economist cited several indicators, including stocks, which he noted normally slide before or simultaneously with recessions. “Stocks are very clearly a leading indicator,” Shilling said. “They tend to lead but not by a lot.”

Shilling expects the recession to be drawn out because the Fed will keep tightening monetary policy for a while and companies will lay off employees.

(Image: Adobe Stock)

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3. The labor market is weaker than it looks.

Real earnings are declining along with weekly hours, indicating the labor market isn’t as strong as jobs data might suggest, Shilling said.

“You see a lot of talk about wages strong and so on but not in inflation-adjusted terms. That’s the way you’ve got to look at this,” he said. “What is the purchasing power if wages are growing 5% and prices are growing 7%? Then real wages are declining 2%,” Shilling explained.

“This does not tell me that we’ve got this supposedly strong labor market,” he said. “I’ve been very suspicious of this. You just don’t have the earnings.” Shilling also noted weak increases in personal consumption expenditures, with real consumer spending up less than 2% year over year. Also, people are digging into their savings, which have declined and are “very low by any historical standards,” and borrowing to make purchases, Shilling said.

(Image: Shutterstock)

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4. Corporate profits will decline more than expected.

With consumer spending weakened, real corporate profits are down year over year as well, Shilling noted.

“The economy is much weaker than many people want to admit and I’m not sure why there is this great reluctance to face the facts. We haven’t had serious inflation since the late ‘60s and 1970s, and to act like it doesn’t exist is ridiculous,” he said.

Wall Street analysts are forecasting slight declines in S&P 500 earnings per share “but I think that’s optimistic,” Shilling said, predicting big declines in corporate profits. That’s typical in a recession, he said, so “why should this be any exception?”

(Image: Adobe Stock)

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5. The Fed will keep tightening even as inflation eases.

Inflation is starting to unwind, although it remains very high, and Shilling expects it will continue to decline. Economic weakness reduces demand relative to supply and pushes prices down, he said, noting that commodity prices have fallen.

Nonetheless, he expects the Fed to keep tightening, possibly until mid-2023.

“The Fed’s going to be sticking to a tighter monetary policy longer,” he said, adding that the central bank and its chairman, Jerome Powell, have a credibility problem.

“I don't think the Fed is going to reverse gears until well into the recession, I would say roughly the middle of next year,” Shilling noted, adding that all major central banks are raising rates to fight inflation.

(Image: Adobe Stock)

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6. Housing has been hit hard by rising rates.

Housing affordability is down as consumers lack the income to keep pace with rising mortgage interest rates, Shilling noted.

“Mortgage applications have really collapsed,” as have refinancings, which means homeowners can no longer take cash from their home equity to pay for other things, he added. Existing home sales also have been sliding, he said, and 30-year fixed mortgage rates are rising faster than 10-year Treasury yields partly because the Fed is no longer buying mortgages.

“Housing is really in trouble,” Shilling said.

(Image: Adobe Stock)

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