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Economist and investor Gary Shilling

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Gary Shilling Sticks to Risk-Off Mode

By Dinah Wisenberg Brin

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What You Need to Know

  • The economist and advisor is still waiting for investors to swear off stocks.
  • Consumer spending and jobs strength boost the odds of more rate hikes, he wrote in his latest outlook.
  • Energy prices, student loan repayments and strikes in the auto industry put drag on the economy, he wrote.

Stocks remain costly given softening economic conditions, according to economist and investment advisor A. Gary Shilling, who also expects the Federal Reserve to continue raising interest rates and for a recession to extend well into next year.

“Stocks are still expensive in relation to weakening profits and the unfolding recession,” he said in his monthly newsletter, Insight, released Wednesday. Repeating his gastrointestinal metaphor for market sentiment, Shilling wrote, “Investors have not yet reached the ‘puke point’ where they regurgitate their last equity and swear off stocks.”

Shilling maintains his “risk off” investing position and noted that the market appears to have moved to the same stance.

“Many investors have hoped for an economic and stock market soft landing with no recession or major bear market. Nevertheless, the jobs market is cooling even as labor becomes increasingly militant,” Shilling wrote.

“Reliable recession harbingers are numerous. High energy prices, resumed student loan repayments, and ongoing auto strikes also drag the economy. Small and riskier firms are troubled by high interest costs. The Fed may raise interest rates further and plans to cut them slowly next year,” he said.

Inflation-adjusted consumer spending is falling, and corporate profits are distressed by higher labor costs that companies can’t completely pass to customers, according to Shilling, who said smaller and more leveraged firms are under pressure.

“Regional banks hold time-bombs in commercial property loans,” he added.

Fed officials recently reduced their forecasts for interest rate cuts in 2024, and continuing consumer spending and employment strength has increased the likelihood of further federal funds rate increases, Shilling said.

Fed officials at their most recent meeting last month signaled they expect to keep interest rates higher for longer into 2024 than they anticipated earlier this year, the economist noted. The Fed probably isn’t done raising its benchmark interest rate, he said, noting that Treasurys have suffered large price declines as interest rates rose.

“Interest rates may be near their peak, but delays in Fed ease and layoffs will extend the recession, which may be underway, well into 2024. Treasury notes and bond yields could fall two to three percentage points, but not to the pre-pandemic lows,” Shilling said.

High interest rates hurt tech stocks and housing, which would benefit from lower rates and could lead early in an economic recovery, he noted.

Shilling is sticking to the nine “risk off” investment themes he has suggested since May 2022, although the rationale has evolved in certain instances. These are, in his words:

  1. Long the U.S. dollar against other major currencies as the world’s premier safe haven and as high interest rates attract foreign money.
  2. Long Treasury bonds. Bonds have been beat up severely but should rally as the recession takes hold.
  3. Sell or short stocks in general as corporate earnings tank and the Fed raises interest rates.
  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 high prices and mortgage rates squeeze out potential new as well as existing house buyers.
  7. Avoid China with a weakening economy after the pandemic lockdown aftermath, the housing sector collapse, and strained relations with the U.S.
  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 extra cash to avoid market losses and prepare for eventual economic and financial market recoveries.

Pictured: Gary Shilling

Dinah Wisenberg Brin

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