Gary Shilling: 30% Stock Drop Is Coming

Economist and investment advisor A. Gary Shilling is sticking with his year-ago forecast that the stock market will experience a roughly 40% peak-to-trough decline and predicts most of the slide will happen in 2023.

Based on a 40% drop from the S&P 500′s peak in January 2022, Shilling’s outlook suggests the index could slide roughly 30% from Wednesday’s close. Despite the stormy stock outlook and his expectations for an extended recession, however, Shilling doesn’t expect a disastrous economic downturn.

“The S&P 500 index is down 15% from its early-2022 top as rising interest rates hammered stock valuations. The bulk of the decline, we believe, will occur this year as the unfolding recession decimates corporate earnings,” Shilling wrote in his monthly Insight newsletter released early Wednesday afternoon.

“With hope springing eternal, many equity investors continue to believe that a recession, or at least another leg down in the equity bear market, will be avoided. That’s despite the Fed’s continual statements that it is resolved to kill inflation … regardless of the negative consequences for the economy,” Shilling wrote.

“Nevertheless, economic and financial data that normally led business downturns indicate that the U.S. economy is either already in or close to a business downturn.”

Consumer spending, which accounts for 70% of gross domestic product, is falling in real terms, as are wages, and households continue to expect lower inflation, Shilling said.

Until equity bulls capitulate, the Federal Reserve will keep credit tight, probably until late this year, he predicted. While inflation in goods prices is receding almost as fast as it surged last year, the Fed has shifted emphasis to services inflation and the wage increases that lie behind it, he said.

Labor markets aren’t nearly as tight as the Fed believes and layoffs are mounting, Shilling wrote. Nonetheless, he added, “the recession will no doubt be extended as employers who only recently expended great effort to hire new employees are hesitant to turn to layoffs even as company sales and profits sink.”

Neither the crypto crash nor the housing nosedive, however, seems large enough to push the 2023 recession into a major disaster, Shilling wrote.

With central bank perseverance and the recession’s negative effects on corporate earnings, the 15% drop in stocks so far since early 2022 “will be augmented by another large fall, propelled by declining earnings, for a total decline of 40%,” he predicted.

Shilling is standing by his “risk off” investment strategies, including:

• Being long the U.S. dollar and Treasury bonds, which started to rally late last year as recessionary weakness in credit demand and their safe-haven status overcame the effects of further Fed tightening.
• Selling or shorting stocks in general as corporate earnings tank.
• Being short speculative stocks such as SPACs and crypto securities.
• Selling growth stocks as the Fed raises interest rates and selling homebuilder stocks as supply jumps while demand falls amid rising mortgage rates.
• Avoiding COVID-related areas, especially China, as the pandemic and housing collapse persist.
• Avoiding “defensive” stocks such as consumer staples, utilities and health care, which drop in bear markets, although not as much as cyclicals and other equities.
• Holding heavy positions in cash to avoid market losses and prepare for eventual economic and financial market recoveries.