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Economist and investor Gary Shilling

Portfolio > Economy & Markets > Stocks

Gary Shilling: Investor Exuberance Is ‘Irrational’

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Economist and investment advisor A. Gary Shilling reiterated his “risk off” strategy on Friday, calling current market exuberance irrational.

Shilling, anticipating credit tightening and a recession, recommended a risk-off strategy in January 2022, and in May last year expanded its recommendations to a nine-strategy list, given his belief that U.S. stocks had entered a bear market.

That list remains in place, he noted in his August Insight newsletter, released Friday.

“This strategy still seems appropriate to us. Persistent gains in employment and high inflation only imply further credit tightening by the Fed, which will break the economy if a recession is not already underway,” he said.

“Nevertheless, security markets recently have been in a ‘risk on’ state, led by the 19% rise in the S&P 500 index so far this year and investor conviction that a ‘soft landing’ with no recession is likely.

“We believe investor exuberance is irrational and will be reversed by recessionary drops in the economy as well as declines in corporate sales and profits,” Shilling said.

In the last month, nonetheless, he said his firm has reduced its short positions in stocks to essentially zero.

“As we first wrote back in 1979, ‘Markets can remain irrational a lot longer than we can remain solvent,’” he said.

Shareholder exuberance, Shilling said, “has priced stocks for perfection, aided and abetted by increasing resort to ‘pro forma’ corporate earnings and other manipulations aimed at making corporate earnings silk purses out of cows’ ears profits.”

The nine strategies that Shilling recommends 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


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