Jonathan Alcorn
Market prognosticator Gary Shilling has made a number of brilliant investment calls over his long career on Wall Street, but one stands out.
Way back in the early 1980s, when nearly everyone thought high inflation would last forever, Mr. Shilling was one of the first to warn that the world was shifting to disinflation.
He thought lower inflation might persist for decades and make high quality U.S. government bonds - then shunned - the best investment around. He took his own advice and loaded up on a leveraged position in long-term U.S. Treasuries, a lucrative trade that made him financially independent for life.
Now, Mr. Shilling, president of A. Gary Shilling & Co. Inc., an economic consulting firm based in Springfield, N.J., is making another the-world-is-changing call. Given his long record of prescience, investors should pay attention.
Mr. Shilling is convinced the United States is about to slip into a lengthy period of weak economic growth, accompanied by 2 per cent to 3 per cent annual deflation - an unusual situation in which consumer prices fall steadily.
In this environment, forget about big gains in the stock market. Equities will produce anemic returns not much more than their dividend yields.
Mr. Shilling is also forecasting disappointment for the many investors crowding into the commodity aisle of the market. In addition, he thinks U.S. house prices could tank another 20 per cent, another blow to the world's largest economy.
Mr. Shilling has outlined his latest forecasts in a new book, The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.
In it, Mr. Shilling has compiled a list of a dozen investment sectors, including commodities and U.S. bank stocks, that he thinks will flop and should be avoided. He's selected another 10, led by his perennial favourite, long-term U.S. Treasuries, now yielding about 4.25 per cent, that he contends will be big money spinners. Although he's down on most commodities, he makes an exception for North American energy producers because the U.S. is looking to lessen its dependence on suppliers from unstable regions.
Treasuries are a controversial bet. Many investment gurus hate them because they believe the Federal Reserve's program of money printing known as quantitative easing will eventually ignite inflation.
While the current interest rates on long-term Treasuries don't seem enticing, Mr. Shilling argues the bonds, whose price moves in the opposite direction to yields, still offer the potential for big capital gains.
Mr. Shilling believes their rates will drop to 3 per cent. If that happens, the securities will return 27 per cent, but if purchased in the form of zero-coupon bonds, the rise will be even sweeter, at 45 per cent.
Long-term Treasuries have "worked for me for 29 years. There is always a risk of overstaying a winning position, but I think if I'm right on slow growth and deflation, it's a very logical investment," he said in a recent interview.
He shrugs off fears about quantitative easing because the Fed's actions to date have only created excess bank reserves. It would take aggressive lending of this money by banks to get inflation rolling, and Mr. Shilling thinks central bankers would then take offsetting action to maintain price stability.
Mr. Shilling's long career has made him one of the elder statesmen of Wall Street. He came to prominence as Merrill Lynch's first chief economist in the late 1960s, when he predicted the 1970 recession, a downbeat message that did not go down well at the company, noted for its thundering herd of bulls image.
Like many investment pros, Mr. Shilling's ideas are shaped by a big picture view of the world economy. From that he drills down into individual markets to look for securities to buy or shun.
His deflation view is based on the idea that such factors as technological innovation are making goods cheaper and more plentiful, driving down their prices. He also contends that deleveraging - the writing off and paying down of debt - is causing an overall lack of demand, which is also deflationary.
Deflation means companies that make big ticket items (think cars or appliances) should be avoided. The same goes for credit card and consumer lenders, antiques and collectibles, commercial real estate, developing country stocks and junk bonds.
Among the investments to be favoured, according to Mr. Shilling, are high quality bonds, stocks of stable companies that pay meaningful dividends, food and consumer-staples producers, rental apartments and the U.S. dollar.
Asked what would make him change his views on deflation, Mr. Shilling said it would be radical monetary policies - such as the Federal Reserve deciding to print money and give it directly to the public to jump-start the economy.
"I don't think that's likely. [Central bankers]fear deflation, but they hate inflation, I think, even more," he said.