Thursday, April 30, 2009

Gary Shilling: inflation or deflation and outlook on economy.

There’s been considerable debate on the inflation versus deflation issue. Last year, this was a little more contentious. (The deflation camp has been right so far and it looks to continue that way). The biggest deflation prognosticator has been "Mr. Long Bond" Gary Shilling. In fact, there was a link to an earlier interview on this blog. If you shorted commodities and went long bonds around then, you would have done well. For the record, he had a 100% accurate record for 2008. Shilling's forecasting an annual deflation of about 2% over the next few years, as consumers save more and the "overall supply of goods and services exceeds demand."

Anyways, came across a recent Bloomberg interview by Gary Shilling. Here's what he had to say. ( Click here or on the image.)

Outlook: His outlook is for a continuing weak economy:

  • Consumer spending in recessions even in real terms seldom declines. We’ve had the worst decline in consumer spending since any post world war recession.

  • PPI numbers clearly suggest we’re in deflation

  • Inventories are only beginning to be liquidated. Going to take economy down for at least next 2 quarters.

On being asked to choose between deflation or inflation, he is sticking to his deflationary thesis:

  • Economy will experience slow growth in the long run.

  • Consumers are on a savings spree after 25 years.

  • The corporate sector is deleveraging.

  • Commodity producers will have less money to spend.

  • Government involvement will slow us down further because of inefficiencies and protectionism.

  • No strong loan demand for a long while. Lenders are not going to lend.

  • So much liquidity has been destroyed in the private sector. Credit default swaps have been cut in half, taking them from 60 to 30 trillion. The total money supply M2 in the G-7 is 25 trillion. So much liquidity is being destroyed in the private sector that it dwarves what the central banks can do and have done.

On the new normal for the US economy:

The 1982 – 2000 period was a solid up phase with a big 3.6% average annual growth. He’s looking at 2% for the next 5-10 years, which is basically the secular down phase of the supercycle.
His recommendations:
  • Still likes long treasuries offering 3% yield on a 2-3% deflation for a 5-6% real return.

  • Likes US dollar as a safe haven.

  • Recommends high quality corporate and muni bonds.

I first came across the works of Gary Shilling(and many others) through John Mauldin’s Just One Thing which I highly recommend :

I’ll be especially interested in following him and watching when he stops recommending long bonds. This is something he’s been doing for over 25 years. It’s been the call to define a lifetime. Long bonds outperforming equities in the great equity bull of 1982-2000 has been a solid sucker punch to the “stocks for the long run" camp in my opinion.