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Gary Shilling Is Still Waiting for Investors to ‘Puke’

By Dinah Wisenberg Brin

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What You Need to Know

  • Economist Gary Shilling says that the bear market likely isn’t over.
  • He also says that a recession is already underway.
  • Shilling doubled down on his nine investment strategies from the past year.

Investors haven’t reached their “puke point” yet, which likely means the bear market isn’t over, economist and investment advisor A. Gary Shilling suggested today in his monthly Insight newsletter, repeating a theme he’s discussed for months.

“The bear market will no doubt persist until investors reach the ‘puke point,’ regurgitate their last equity and swear never to buy another,” said Shilling, who believes a recession is underway. “Then selling will be exhausted, leaving only potential buyers.”

He cited current investor bullishness — especially individual stockholders’ optimism — as a red flag for equities.

“An Investors Intelligence survey recently jumped from 40.8% to 48.6%, the highest bullish reading since February,” Shilling wrote. “Individual investors bought $78 billion in stocks and exchange-traded funds in the first quarter, near the $80 billion recorded in the first quarters of 2021 and 2022. And that’s with the average individual investor’s brokerage portfolio down 27% from the November 2021 peak.”

Except for energy, stocks across the board have fallen in this bear market, including defensive stocks such as utilities, consumer staples and health care, he said, adding, “Despite declines, equities are still very expensive.” Speculative investments like cryptocurrencies and special-purpose acquisition companies have evaporated, Shilling said.

And energy stocks may not continue their bear market rise, with Western restraints on Russian oil exports and global economic weakness depressing crude oil prices, Shilling wrote.

“We continue to believe that as the global recession deepens, the second leg of the bear market in stocks, driven by falling corporate sales and earnings, will unfold. The first leg, propelled by Fed tightening, has cut the S&P 500 index 13% from its Jan. 3, 2022, top,” he wrote.

“That index would have to drop another 31% from here to reach our long-held total decline target of 40%. That would be equal to the 40% total fall on average in previous post-World War II recessions,” he said.

Recession Likely Underway

“The recession is no doubt underway but won’t be ‘officially’ declared for months or even quarters” as the National Bureau of Economic Research has yet to call a recession, he wrote, adding that “most leading indicators foretell an economic decline.”

Federal Reserve credit-tightening to wrestle inflation back to 2% caused the first phase of economic weakness and market decline, while the second leg results from falling economic activity as well as declining corporate sales and profits, according to the economist.

“Central banks and other government agencies here and abroad are containing the run on banks, but as they tighten bank regulations and [as] scared banks hype lending standards while depositors flee, credit availability will shrink, to the detriment of the economy,” Shilling said.

The recent Silicon Valley Bank and Signature Bank failures and the First Republic Bank collapse “brought hopes of a reversal in monetary policy as many worried about widespread bank runs. But bailouts of those troubled institutions have eliminated the likelihood of widespread bank runs and left the central bank free to pursue its credit-restraint policy,” he said.

Labor markets are easing as hours worked and real pay fall, leading to layoffs and allowing employers to be choosier, Shilling wrote, adding that companies are “opting for older, self-disciplined and reliable employees who are accustomed to hard work.”

Meanwhile, commercial real estate is joining housing in the tank as vacancies and financing costs leap, leading to suffering for businesses and cities that depend on office worker spending and property taxes, he said.

Enduring Strategy

Shilling reinforced the risk-off investment themes his firm recommended a year ago, saying, “The unfolding recession and spreading bank crisis intensify our conviction that this investment strategy is valid.”

They 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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