Shilling's New Anti-Deflation Strategy
11/12/2009 1:00 pm EST
Gary Shilling, editor of INSIGHT, unveils his new investment strategy, based on the prospect that hard times will continue for years to come.
Our investment themes continue to center around a further weakness in housing and a recession that we believe is not yet over as US consumers continue to retrench. We also believe that a faltering economy will put more pressure on profits and stocks, and initiate chronic deflation, supporting lower Treasury yields. We expect the dollar to rally as economic weakness abroad exceeds that in the US and as commodities resume their weakness.
[Here are] the investment areas in which we have positions, along with brief explanations.
Long Treasury bonds. The yield on the 30-year bond fell from 4.5% to 2.6% last year, but then jumped back to 4.5% by mid-2009. Nevertheless, yields have fallen on balance since June back to 4.3% despite the continuing rally in stocks. Maybe this bond rally reflects the continuing recession we foresee and the return to Treasuries as a safe haven. We continue to expect yields to drop to 3% or lower on 30-year Treasuries.
Short UK pound. We’re itching to short euros against the dollar. We expect the global recession to persist and the buck’s safe haven status to return. The greenback is universally hated, and too many are on the dollar-dumping side of the boat.
Meanwhile, we’re short British sterling. The UK economy remains in deep trouble with an overweighted financial sector. Almost alone among developed countries, British real gross domestic product fell in the third quarter.
Short regional and smaller banks hedged by long large banks via ETFs. Regional and smaller banks are dropping like flies—over 106 so far this year have essentially failed. Many more are on the way due to bad loans, especially on commercial real estate. Large banks have been bailed out and stabilized. Their stock rallies may be over, but they can serve as hedges to offset, at least in part, any further general stock rally that could spill over to regional and smaller banks.
Long big corporations, short small company stocks. Weak revenues and tight financing are squeezing small corporations. Their managements are also cutting employment and delaying expansion due to uncertainty over Washington’s plans to increase their employee health care costs, raise taxes, and increase their energy and other costs through environmental regulation. We’re hedging our shorts on small company stocks with longs on large-cap equities.
Long high-quality municipal bonds. We have long-held high-quality muni positions in some taxable accounts. They’ve rallied this year after big declines last year, but we consider them multiyear investments.
Long five-year Treasury notes. With three-month treasury bills yielding 0.046%, we’ve moved out on the yield curve for what is essentially cash positions in some cases. Sure, five-year obligations are much more volatile than three-month bills and do have risk of loss if interest rates rise. But we think the direction is down in that part of the interest rate curve, and 2.4% returns vs. 0.046% seem enough to offset the risks.