Economist Gary Shilling warns of hard times ahead

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

Among his many virtues, A. Gary Shilling doesn't pussyfoot around. Unlike other economists, he doesn't say "On the one hand" this, "On the other hand" that. He makes straightforward predictions and gives straight-from-the-shoulder advice.

One result, of course, is that sometimes he is spectacularly wrong-for example, he didn't foresee the recent gigantic stock-market rally. On the other hand (we journalists are allowed to say that), he has, extraordinarily often, been spectacularly right. In, for example, recommending long-term Treasuries — since 1981. (Had I only listened!)

That, he confirmed, was his most prescient call. In the early 1980s, when inflation was raging, he predicted that inflation would subside-which would be auspicious for both stocks and bonds. His first book, "Is Inflation Ending? Are You Ready?," written in 1981-82, was finally published in 1983-and, sad to report, "nobody believed it."

The Sage of Springfield reports that he has enjoyed four good calls in his career, or less than one a decade during his 46 years of forecasting-and when he's real sure, he bets the house.

Shilling is a contrarian — or, as he prefers to put it, a realist. When everyone else is busy buying x, he's busy buying y and selling x; and vice versa.

Why does contrarian investing work? "When markets have reached their peak, everyone has been sucked in," he replies. "So you've run out of buyers-and all that's left are sellers. And after all the selling, you run out of sellers-and all you have left are buyers."

Investors aren't skeptical because they habitually defer to the crowd: They have a "willing suspension of disbelief," Shilling says, quoting the poet Samuel Taylor Coleridge.

Why did he become a contrarian?

Long ago, he realized that the market anticipates things-"It discounts everything that's known. So, if you want to add value, you can't just rehash the consensus. Why pay me for advice, when you can just read the newspaper?" That led him to concentrate on trends that were being ignored or underestimated.

A good contrarian call, he says, has three components:

1. The change is important. It affects many people; it can be profitable.

2. There's a good chance of its happening soon.

3. It's outside the consensus view. (Two years ago, Shilling took part in an investment discussion that I had arranged. He recommended Treasuries. A bond "expert" was skeptical — loudly and rudely. Last year 30-year Treasuries were up 42%, while almost everything else was down.)

In making judgments, Shilling confesses, "There's a lot of room for human fallibility. So you have to bide your time waiting for a special opportunity." (His strategy, obviously, is similar to Warren Buffett's.)

Bad news.

Shilling is not exactly a cockeyed optimist now. Our lives will be very different during the next decade, he predicts, mainly because Americans are changing from spenders to savers.

He thinks the economy won't recover until next year, and then only anemically; that real estate will remain in the doldrums (thanks to the flood of unsold houses, prices should decline another 10%); and that the stock market will just tread water. He even thinks this Christmas season will disappoint retailers. (Or, as he cheerfully put it, "Bah, humbug.")

So, what does he like?

Stocks that pay generous dividends, like utilities;
High-quality bonds, especially Treasuries;
The dollar (I told you he was a contrarian);
Consumer staples and foods;
Companies that sell small luxuries-like high-priced brands of liquor and wine, along apparel, shoes, handbags, and watches that are moderately priced versions of luxury brands.
Investment advisers and financial planners;
Health care-the trend toward general economizing won't affect the wealthy, so he likes upscale nursing homes and expensive elective procedures, like laser eye surgery.
Productivity enhancers-like continued outsourcing.

As for what to avoid, his list includes antiques, art, and other tangibles; junk bonds; credit-card companies; conventional home builders; and commodities.

Unlike other economists, Shilling has a good sense of humor. And he writes in a lively way. Example: Consumers have gotten spooked, and "Women are ‘shopping in their closets' for apparel rather than in stores, and some are turning their homes into boutiques to sell their excess clothing and jewelry. Many brides need cash after weddings that cost $22,000 on average...so they are selling their wedding gowns after the ceremonies to cost-conscious brides-to-be."

Just to underscore how unusual a person Shilling is: He once told me that, at his summer home, he keeps 26 bicycles-for visiting guests; he isn't interested in music written after Bach; and one of his hobbies is bee-keeping.

He graduated from Amherst, magna cum laude, majoring in physics, then got his M.A. and Ph.D. at Stanford. Before starting his own business, he was the first chief economist at Merrill Lynch.

His very informative, very opinionated monthly newsletter, Insight, costs $275 a year, in a scaled-down edition, and $1,000 unscaled-down. He also has a regular column in Forbes since 1983-in fact, he's written for Forbes longer than any other Forbes columnist.

Now, New Jersey is the state that produced Frank ("I am the law") Hague, former Mayor of Jersey City; a Congressman who ran for re-election while he was serving time in jail (surprisingly, he lost); and any number of gangsters (Willie Moretti, Longie Zwillman, Dutch Schultz, et al.). So it's good that New Jersey can boast of harboring at least a few estimable people like Gary Shilling.

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