Gary Shilling Is Still Waiting for Investors to ‘Puke’

Recession Likely Underway

“The recession is no doubt underway but won’t be ‘officially’ declared for months or even quarters” as the National Bureau of Economic Research has yet to call a recession, he wrote, adding that “most leading indicators foretell an economic decline.”

Federal Reserve credit-tightening to wrestle inflation back to 2% caused the first phase of economic weakness and market decline, while the second leg results from falling economic activity as well as declining corporate sales and profits, according to the economist.

“Central banks and other government agencies here and abroad are containing the run on banks, but as they tighten bank regulations and [as] scared banks hype lending standards while depositors flee, credit availability will shrink, to the detriment of the economy,” Shilling said.

The recent Silicon Valley Bank and Signature Bank failures and the First Republic Bank collapse “brought hopes of a reversal in monetary policy as many worried about widespread bank runs. But bailouts of those troubled institutions have eliminated the likelihood of widespread bank runs and left the central bank free to pursue its credit-restraint policy,” he said.

Labor markets are easing as hours worked and real pay fall, leading to layoffs and allowing employers to be choosier, Shilling wrote, adding that companies are “opting for older, self-disciplined and reliable employees who are accustomed to hard work.”

Meanwhile, commercial real estate is joining housing in the tank as vacancies and financing costs leap, leading to suffering for businesses and cities that depend on office worker spending and property taxes, he said.

Enduring Strategy

Shilling reinforced the risk-off investment themes his firm recommended a year ago, saying, “The unfolding recession and spreading bank crisis intensify our conviction that this investment strategy is valid.”

They are:

1. Long the U.S. dollar against other major currencies as the world’s premier safe haven.
2. Long Treasury bonds. Bonds were beat up earlier, but beginning to rally last October as recessionary weakness in credit demand and their safe-haven status overcame the effects of further Fed tightening.
3. Sell or short stocks in general as corporate earnings tank.
4. Short speculative stocks such as SPACs and crypto securities as speculations continue to come to grief.
5. Sell growth stocks as the Fed raises interest rates, making the present value of their future earnings, i.e., the current stock prices, lower.
6. Sell homebuilder stocks with supply jumping while demand falls as mortgage rates continue to rise.
7. Avoid COVID-related areas, especially China, as the pandemic and housing collapse persist.
8. Avoid “defensive” stocks such as consumer staples, utilities and health care, which drop in bear markets, although not as much as cyclicals and other equities.
9. Hold cash to avoid market losses and prepare for eventual economic and financial market recoveries.

(Pictured: Gary Shilling)