Gary Shilling: Get Defensive

Markets are hanging on every pronouncement from the Fed, and rate hike expectations have repeatedly been pushed back. While many still expect the next move to be up, Gary Shilling, financial analyst and author of The Age of Deleveraging, recently told Financial Sense that he thinks the Fed won’t be able to raise rates. Instead, he expects to see rates fall.

Here is an abbreviated version of his interview, which aired last weekend on our podcast (see An In-Depth Discussion With Dr. Gary Shilling for the full audio).

Bubble Trouble

When people don't believe a bubble exists, that's exactly when the possibility for one is greatest, Shilling explained. For example, in the case of the housing market early last decade, he said, people were convinced the market would never correct.

“Of course, that is when bubbles break,” he said. “It’s what’s going on now. It’s a potential bubble.”

With interest rates at historic lows in the US, and with negative rates in Europe and Japan, we’re seeing people assuming all kinds of risk, he added. Individual investors to pension funds have been encouraged to move out on the risk curve because the alternative is poor returns.

It seems that people are abandoning hedge funds and moving into real estate, Shilling noted. Of course, this creates the risk that anything investors chase will be overdone, leading to still more bubbles forming.

"Not Going to Be Pretty"

Instead of focusing on nominal rates, we need to look at real interest rates, adjusted for inflation, Shilling argued. Under that rubric, we see that rates have been negative several times in history.

“When we get enough perspective—we’re going to find that this whole situation with negative nominal interest rates and with very aggressive monetary policy—has not done much for economic growth, (along with) all the confusion this has created,” Shilling said.

We have a situation where most people in Europe and North America have seen declines in their purchasing power for over a decade, Shilling said, and he thinks voters are furious at this point, which partially explains the populism sweeping the Western world.

“I wish we could pull out the crystal ball and see what is going to come out of this,” he said. “I rather suspect that it’s not going to be pretty to go through.”

Because of the low inflation and deflation that we’re seeing, Shilling still expects that his call for still-lower rates in certain US Treasuries to come to fruition. Inflation expectations and safe-haven buying are the driving forces here, Shilling stated, and he is looking for 1 percent on the 10-year and the 2 percent on the 30-year Treasury note.

This won’t deter investors, Shilling noted, as interest rates can go lower or even negative, and he added that he owns Treasuries for capital appreciation, rather than yield.

What’s the Fed Going to Do?

In a recent letter, Shilling said the Fed’s next move will be to lower interest rates.

“The Fed has had a very poor record in forecasting through this expansion,” he noted. “They have consistently over-estimated economic growth and underestimated inflation.”

Though the Fed did raise rates slightly last year, he thinks this has more to do with their need to retain credibility. With ongoing global economic weakness and signs growth is slowing yet again, he thinks the overall atmosphere is more conducive to reducing rates rather than raising them.

Ultimately, central bankers are too mired in an academic mindset, Shilling said and are out of touch with what’s going on. Fundamentally, he thinks the Fed’s use of forward guidance is creating more distortions than it’s helping to resolve.

Additionally, Shilling argues that the published unemployment figures are distorted, and real unemployment is probably closer to 11 percent, because of the declines in the number of people looking for work.

Ultimately, he expects to see “helicopter money” in the form of both monetary and fiscal stimulus taking hold. With the overhang of debt globally and the chance for more fiscal stimulus, Shilling thinks we’ll see more slow growth as a result. If we see the cost of debt increase, he added, we might be facing serious issues, which further constrains the Fed’s course of action.

“(A huge increase in interest rates) in itself can upset the apple cart,” he noted. “If that happened, I think we would have a lot more important things that we would need to worry about.”

Shilling advocates holding Treasuries and cash right now in a defensive stance. Ultimately, he expects the next move on the Fed’s part is to lower, and not raise, interest rates.

To listen to this full interview with Gary Shilling, renowned economist and author of The Age of Deleveraging, click here. Want to listen to the BEST financial podcast on the web? Click here and subscribe today!

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