Shilling, Rosenberg: 5 Red Flags, One Green Flag for Investors

Slideshow February 12, 2024 at 02:40 PM Share & Print

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The S&P 500 is setting new highs but the picture isn’t quite as rosy as it seems, according to economist and advisor A. Gary Shilling.

In a wide-ranging webcast last week about the financial markets and the economy, Shilling also suggested a recession may yet materialize in 2024. He called bitcoin highly volatile “hocus pocus” with no underlying value.

Shilling appeared on his webcast with guest David Rosenberg, founder and president of the economic and financial market consulting firm Rosenberg Research, who warned about the risks in highly concentrated stock markets like the current one.

Here are five market and economic signals for caution, and one investing opportunity, from Shilling and Rosenberg.

Dinah Wisenberg Brin

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1. The S&P rally in context is less impressive.

“When it comes to stocks, people look at them in nominal terms. In other words, they're really inflating things as a result,” Shilling said, noting the S&P 500’s new highs last week. “But if you adjust for inflation, it's still about 8% below its previous peak. I'm simply saying you've got to take the Wall Street bulls with a grain of salt and look at reality.”

Stocks, he added, “are very, very expensive.” Looking at cyclically adjusted price-to-earnings ratios over the last 10 years, adjusted for inflation, the long-term S&P 500 average is 17, while recently it was 31.56, Shilling said. It would take a 46% decline to bring that back to the long-term average, he added.

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2. Bitcoin is fueling speculation.

“Not only are stocks expensive just in general, but you've had so much speculation. Here's bitcoin. For my money, bitcoin is simply a black box. It's hocus-pocus. There's nothing substantial behind it. There's no value. There's no assets. It's purely speculative. And you look at what happens, very volatile, but tremendous increase in that speculation.”

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3. The Magnificent 7 could be in for a bruising.

Shilling warned about speculation in the Magnificent Seven tech mega-stocks too, and noted the term comes from films about gunslingers, or Samurai, who save a village.

“What's interesting about the movie, at least, is that only three of the seven survived,” Shilling said.

When the market is concentrated on a few stocks, it means investors aren’t happy about the rest of the market or the economy, he added.

The “Nifty 50” stocks in the early ’70s gave investors the sense they’d only buy them and would never sell, but it got down to four stocks — Disney, McDonald’s, Winnebago and Polaroid.

“I think that we're dealing with a similar speculative situation now, which is cruising for a bruising. So I'm very concerned that you've got just a very distorted financial picture, particularly in equities.”

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4. Beware: The ‘landing’ may not be so soft.

“There's a tremendous conviction now that the economy has achieved a soft landing, meaning no recession. And that may be, but there's still some nagging evidence to the contrary,” Shilling said, noting the negative 2-year and 10-year Treasury yield curve, among other signals.

The federal funds target rate, for example, “is almost a perfect forecast of recession,” Shilling said.

Rosenberg noted that lags in the effect from monetary policy can be long and variable, and may be longer this time following the pandemic-related stimulus. Excess savings “have pretty well gone dry,” he added.

That doesn’t mean a recession isn’t coming, Rosenberg suggested. “My slogan is that delay does not mean derail.”

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5. Fed will be slow to cut rates.

Because the Federal Reserve was late in tackling inflation by raising interest rates, it will be very slow to reduce rates, Shilling predicted.

He also suggested the Fed “really wants to make sure that labor markets are softening before they ease,” and it will be well into this year before it starts to cut rates. “And when they do, it'll probably be a very slow process.”

Rosenberg added that the typical lag from the last hike to the first cut is 10 months, which suggests May or June for the Fed to start easing. He predicted the economy “will show more visible signs of deterioration by then. So they'll have more of a green light.”

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6. Treasurys present an opportunity.

Stocks are very expensive relative to Treasurys now, Shilling said.

He and Rosenberg noted investors don’t buy bonds for the yield, but for the price appreciation, which is attractive now.

“You make money in bonds principally because of the price return. And most people don't understand that. Certainly nobody in the equity market understands bond math. It's really interesting. Who would buy a 4% 10-year or 4.5% long bond” to hold onto, Rosenberg asked.

“This is all about what is the expected 12-month return. If I'm right that the yield curve goes down 100 basis points, you will make equity-like returns in the bond market without taking on equity capital risk. And to me, that is the trade of the year,” Rosenberg said.

Shilling displayed a chart showing an average 29% S&P 500 decline over numerous recessions, noting, “if there is a recession … you don't want to be in stocks. You want to be in Treasurys.”

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