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Gary Shilling Warns 'Violent' Stock Drop Could Be Ahead

By Dinah Wisenberg Brin

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What You Need to Know

  • The Fed will eventually drive investors to the point at which they can't stomach another stock, Shilling says, repeating a theme.
  • Investors have followed this pattern in the 12 post-World War II bear markets associated with recessions, he said.

Economist and investment advisor A. Gary Shilling maintains his view that the stock market is headed for a downturn, predicting the Federal Reserve will ultimately defeat investors who doubt the central bank will keep tightening credit until it subdues inflation and global economies retreat.

The Fed and other major major Western central banks are determined to push annual inflation to 2%, he noted in his July Insight newsletter, issued Friday.

“We continue to believe the Fed will win the tug of war with equity investors, with victory signaled by stockholders reaching the Puke Point as they regurgitate their last equities and swear to never buy another. That leaves the stock market depleted of potential sellers and facing nothing but potential buyers,” Shilling said.

“This pattern has been the case in the 12 bear markets associated with recessions in the post-World War II years,” he continued. ”The lack of a meaningful stock decline recently may forerun a violent ‘catch-up’ drop in the future.”

In previous newsletters, Shilling predicted the S&P 500 would fall 40% from its Jan. 3, 2022, peak. After the market’s recent rally, the index closed Monday down about 7.1% from the close on that date. (In his May newsletter, he noted stocks were 17% off the peak and suggested they had another 28% to go to reach his firm’s target.)

While Shilling didn’t cite that specific 40% prediction in his most recent newsletter, except in synopses of his earlier commentaries, his firm confirmed Wednesday he’s sticking with that view.

As for the U.S. economy, Shilling evoked the old “if it looks like a duck, quacks like a duck and walks like a duck, it probably is a duck” observation to suggest it has entered a recession, even if one has not been officially called yet.

“Today, the U.S. economy looks recessionary, feels recessionary and, except for yet-to-collapse employment and equities, acts recessionary. If jobs and stocks are as vulnerable as we believe, all doubt about recession will no doubt soon be removed,” he wrote.

Shilling also stuck with the nine investment strategies that he recommended in May 2022 when he suggested U.S. stocks had likely entered a bear market. “This strategy still seems appropriate to us. Persistent gains in employment and high inflation only imply further credit tightening by the Fed, which will break the economy if a recession is not already underway,” he wrote.

These strategies are:

  1. Long the U.S. dollar against other major currencies as the world’s premier safe haven.
  2. Long Treasury bonds. Bonds were beat up earlier, but beginning to rally last October as recessionary weakness in credit demand and their safe-haven status overcame the effects of further Fed tightening.
  3. Sell or short stocks in general as corporate earnings tank.
  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 mortgage rates continue to rise.
  7. Avoid COVID-related areas, especially China, as the pandemic and housing collapse persist.
  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 cash to avoid market losses and prepare for eventual economic and financial market recoveries.

Pictured: Gary Shilling

Dinah Wisenberg Brin

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