This week I am really delighted to be able to give you a condensed version of Gary Shilling’s latest INSIGHT newsletter for your Outside the Box. Each month I really look forward to getting Gary’s latest thoughts on the economy and investing. In 2009 in his forecast issue he suggested 13 investment ideas, all of which were profitable by the end of the year. Last year he gave us 16 which the large majority hit the mark. It is not unusual for Gary to give us over 75 charts and tables in his monthly letters along with his commentary, which makes his thinking unusually clear and accessible. Gary was among the first to point out the problems with the subprime market and predict the housing and credit crises. His track record in this decade has been quite good. I want to thank Gary and his associate Fred Rossi for allowing us to view this smaller version of his latest letter, where he gives us 18 investable strategies for 2011
If you are interested in subscribing to his letter, his web site is down being re-designed, but you can write for more information at insight@agaryshilling.com. If you want to subscribe (for $275), you can call 888-346-7444. Tell them that you read about it in Outside the Box and you will get the full 2011 forecast with price targets, plus an extra issue with his 2012 forecast (of course, that one will not come out until the end of the year. Gary is good but not that good!) I trust you are enjoying your week. And enjoy this week’s Outside the Box….
Oh, I can’t resist. Remember that list of the differences between the payroll differences between private and federal employees I had in the last letter? Rob Arnott wrote and pointed out that the biggest differential was in the cost of public relations personnel. I guess the cost of high quality practitioners of “spin” is seen as a necessary expense for the government.
Your enjoying the irony analyst,
John Mauldin, Editor
Outside the Box
2011 Investment Strategies: 9 Buys, 9 Sells
(excerpted from the January 2011 edition of A. Gary Shilling’s INSIGHT)
As in the past, our investment strategies for 2011 are driven by our forecasts for the economies and financial markets here and abroad. In our view, the overarching reality that will dominate 2011 and, indeed, the next decade or so is financial deleveraging, as spelled out in our new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation, which was published in November 2010 by John Wiley & Sons.
We look for slow U.S. economic growth of 2% or less this year. The post-recession inventory bounce is over. Consumers are probably more interested in saving and repaying debt than in spending. State and local government spending and payrolls are falling. Excess capacity will retard capital equipment spending while low rents curtail commercial real estate construction. Economic growth abroad is unlikely to kindle a major export boom. Housing is overburdened with excess inventories. QE2 will be no more effective than QE1 in spurring lending and economic growth, while net fiscal stimuli will decline $100 billion in 2011 compared with 2010.
With slow growth, only a moderate shock will initiate a recession. Candidates include the deepening Eurozone crisis, a hard landing in China, and the 20% further drop in house prices we expect over the next several years. That would push underwater mortgages to 40% and hype strategic defaults while severely damaging consumer spending and the economy. In this environment, here are our 18 investment strategies for 2011.
1. Buy Treasury Bonds. We’re deliberately listing this strategy first not because of nostalgia, although this strategy has worked for us for 29 years on balance, and has been our most profitable investment. Instead, it’s because we expect further substantial appreciation with 30-year Treasury bonds, and because so few other investors believe our forecast has any chance of being realized. Fundamentally, we favor Treasury bonds…
—Because we foresee slow economic growth at best in coming quarters and years
—Because the Fed is determined to further reduce interest rates
—Because deflation is looming
—Because long Treasury bonds are attractive to pension funds and life insurers that want to match their long-term liabilities
with similar maturity assets
—Because as the U.S. moves ever closer to the slow growth and deflation of Japan, the parallel trends in government bond
yields seem likely to persist
—Because Treasurys are the safe haven in a sea of trouble in the Eurozone and elsewhere
—Because China’s attempts to cool her economy will probably precipitate a hard landing
—Because the likely price appreciation in Treasurys is in stark contrast to expensive stocks and overblown and vulnerable
commodities, foreign currencies, junk securities and emerging market stocks and bonds. We continue to predict that 30-year Treasurys, “the Long Bond,” will rally from its current yield of about 4.4% to 3% with appreciation of around 2.6%. Similarly, a 30-year zero-coupon Treasury would gain 48%. We also expect the 10-year Treasury note yield to drop from the present 3.3% level to 2.0%. but the appreciation would be only 11%, largely because of its shorter maturity.
2. Buy Selected Income-Producing Securities. This includes the high-quality corporate bonds although their spreads vs. Treasurys narrowed to 1.7 percentage points in 2010 through November from 2.1 in 2009 and 6.3 in 2008. We also continue to favor stocks of utilities, consumer product companies, health care firms, and others that pay meaningful dividends that are safe and likely to rise. Master limited partnerships are also possibilities, but only if their underlying businesses are secure enough to continue significant income payouts. Banks used to pay significant dividends but slashed them when their earnings collapsed. Nevertheless, their deleveraging and reversion to safer but less growth-oriented businesses is pressuring them to again pay attractive dividends, and regulators may soon allow them to do so.
Dividends Are Back
After a long hiatus, companies that pay substantial, predictable, and meaningful dividends may be coming back into style for two distinct reasons. First, in a post-Enron/Arthur Andersen world and after gigantic write-downs have made reported earnings for many companies questionable, a company paying meaningful dividends is, in essence, assuring investors that it is generating the real earnings and real cash flow needed to finance those dividend checks.
Furthermore, a significant dividend payer will almost certainly continue to be run in a prudent and stable manner. Dividend cuts forced by the down phases of volatile earnings patterns are not loved by investors, as was shown when many financial institutions slashed or eliminated their dividend in 2008. Second, dividends may provide the lion’s share of earnings for many companies in future years, as discussed in The Age of Deleveraging.
Another reason that dividend-paying stocks are likely to be popular in coming years is a change in attitude by institutional investors, especially endowments and pension funds. In 2008, virtually all of the 40 investment classes we identified fell. That included U.S. stocks, foreign stocks in developed countries, emerging market stocks and bonds, junk and even investment-grade bonds, commercial and residential real estate, commodities, and foreign currencies against the dollar. In fact, Treasurys, gold, and the dollar against foreign currencies except the yen were about the only things that rose in price in 2008—classic safe havens.
3. Buy Small Luxuries. Consumers, especially when they’re hard-pressed as many are now, tend to buy the very best of what they can afford, even if it’s within a low-priced category. We developed this investment theme of small luxuries years ago when we noticed this tendency in apartheid South Africa. Urban blacks there often carried the elegant, slim, and expensive umbrella typical of investment bankers in London. They couldn’t afford cars or even taxi fares, but they did achieve status and satisfaction with fine umbrellas.
We think manufacturers and retailers that can adapt to the demand for small luxuries will be winners in the current environment. Some are adopting the small luxury mode by offering essentially the same products at lower prices by cutting their manufacturing costs.
Another route to small luxury success is to continually introduce new and improved models that make their predecessors obsolete. Apple is the master at this strategy, and the iPhone made the cell phone in my jacket pocket utterly antediluvian and forced me to upgrade to an iPhone. When my wife saw it, she realized her two-year-old model was obsolete so I gave her a new iPhone for Christmas. Of course, the new iPad, which she also got for Christmas, positively reeks of small luxuriousness since it’s too big for your pocket and will be visible to all your envious friends. Last fall, some back-to-school spending was diverted to iPads and other electronic gadgets.
4. Buy the U.S. Dollar, especially against the euro. Dumping on the dollar has been the favorite sport of investors and the financial media for years. Then the financial meltdown in 2008 drove investors to the dollar as the global safe haven, but in early 2009 that status faded as fears of financial collapse melted. Buck busters cited the record low short-term interest rates, with the federal funds target rate at zero to 0.25%, even lower than in Japan. This made the greenback the preferred funding currency for the carry trade in which it was borrowed and then sold for higher-yielding currencies, such as the Australian dollar or the Norwegian krona. The falling dollar against those currencies also enhanced the profitability of those trades.
Buck dumpers also emphasized the tremendous number of dollars being pumped out by the Fed and the Treasury in their attempt to revitalize the economy, and the Fed’s clearly stated commitment to keep short-term interest rates low for an extended period. Furthermore, the left-leaning Congress and administration didn’t help the dollar with their twin goals of increasing government regulation and control of the economy and redistributing income from the higher-income people to lower-income households. These anticapitalistic policies tend to discourage foreign investors and encourage Americans to invest abroad.
The Reserve Currency
Despite all its drawbacks, however, the dollar remains the world’s reserve currency and safe haven, regardless of suggestions by the Chinese and others that the dollar should eventually be replaced by a global currency. But alternatives to the dollar as the world’s reserve currency don’t exist. British sterling had that role in the 19th century, but it disappeared along with the British Empire. Switzerland’s economy and franc are safe and sound, but too small for global scale. Japan doesn’t want the yen to be a global currency. Ditto for China with the Yuan, which remains tightly controlled. What’s left?
Our basic argument for the greenback isn’t that the U.S. is a shining example of fiscal prudence and monetary integrity, a global example of a high saving, high investment economy driven by productivity growth. Rather, it’s our conviction that the dollar is the best of a bad lot and, at least for the next decade or so, the only reserve currency in town. The continuing purchases of Treasurys and other dollar-denominated assets by the central banks of developing countries with big current account surpluses suggest that they agree with us. In the third quarter of 2010, they (not including China) increased their dollar holdings by $416 billion and dumped $17.7 billion worth of euros, according to IMF data
Furthermore, until early 2010, almost everyone was on the dump-the-dollar side of the boat, a situation similar to that early in 2008 that preceded the dollar’s jump which started in mid-year (Chart 1). History suggests that when that happens, the winds often shift and all those folks will get tossed into the water as the boat sails in the reverse direction
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Many years ago, I met Umair Haque through his website Bubble Generation, and his many manifestos.
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