Additional Praise for The Age of Deleveraging
“Gary Shilling provides a compelling and comprehensive assessment of the looming deflationary backdrop. This is a highly valuable resource to help the investor navigate through the postbubble economic volatility of our times.”
—David A. Rosenberg, Chief Economist and
Strategist Gluskin Sheff + Associates
“Particularly given what's unfolding in world markets, this is a must read. It's well written, engaging, enlightening, relevant, and very up to date with today's economic landscape. It concludes with 12 specific sell ideas and 10 specific buy ideas. Buy it.”
—Ed Hyman, Chairman of ISI Group, Inc. (broker dealer) and
ISI Inc. (funds management)
“Gary Shilling is a master at recognizing the reversal of long term trends while everyone else is still looking in the opposite direction. Even more important, he shows his readers how to protect themselves and profit from his insights. It's vintage Gary!”
—Terry Savage, nationally syndicated Chicago Sun-Times financial
columnist and author of The Savage Truth on Money
“Gary Shilling told you so—and now, in this primer on the forces of economic and financial gravitation, he's telling you again. Pay heed!”
—James Grant, Grant's Interest Rate Observer
“Gary Shilling is a rare bird: a certified economist who nonetheless is thoroughly imbued with common sense—and has stellar records in two of the world's more parlous occupations, forecasting and investing, to prove it. His latest book, The Age of Deleveraging, is a gift, pure and simple, to the legions of investors who want to know what's hit them as this “post-Lehman world” flirts with deflation and—more urgently—what to do now. Read it and profit.”
—Kate Welling, Editor/Publisher,
“Gary Shilling's book provides insight into leverage, excessive speculation and the underlying deflation in our economy. He is unique among his colleagues for the persistence in which he has maintained these views.”
—Richard S. LeFrak, Chairman and
CEO of the LeFrak Organization
Copyright © 2011 by A. Gary Shilling. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at . Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at .
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Library of Congress Cataloging-in-Publication Data:
Shilling, A. Gary.
The age of deleveraging : investment strategies for a decade of slow growth and deflation/A.
Gary Shilling.
p. cm.
Includes index.
ISBN 978-0-470-59636-4 (cloth); ISBN 978-1-118-15018-4 (paper);
ISBN 978-0-470-91831-9 (ebk); ISBN 978-0-470-91833-3 (ebk);
ISBN 978-0-470-91834-0 (ebk)
1. Investments–United States. 2. Investment analysis–United States.
3. Deflation (Finance)–United States. 4. Economic forecasting–United States.
5. United States–Economic conditions–2009- I. Title.
HG4910.S458 2010
332.6—dc22
Foreword
When one thinks of the term “Renaissance Man” in conjunction with the world of investing, trading, and economics there are really very few names that come swiftly to mind. Wall Street is simply not known for its sense of art, or history, of philosophy, of literature, or of music. There are some from the past that come to mind of course, as great philanthropists to the arts, but they were philanthropists simply to buy a place in history rather than as a respecter of history and the arts. I have been fortunate, however, to have met a true Renaissance Man, and you are fortunate enough to be about to read one of his books. When I think of a Renaissance Man on Wall Street, I think instantly of my dear friend, Dr. A. Gary Shilling. Gary is a gentleman who can, with the best of them, launch into a discussion of Shakespeare's tragedies, and can instantly recognize the composer of a piece of classical music—and perhaps even name the conductor and the orchestra playing the piece in question. He understands the lessons of history through the ages and can discuss with alacrity and clarity the importance of the adjusted monetary base as reported by the Federal Reserve Bank of St. Louis or, just as readily, the implications of a revision to monthly durable goods orders. Gary is a true Renaissance Man, and he's taught me much.
I first became aware of Gary's economic forecasting abilities back in the early 1970s, when I was one of the young economists at Cotton, Inc. in Raleigh, North Carolina. My duties were to forecast cotton supply and demand statistics as well as generate a view on the economy that we could send to the cotton producers of America, who were our clients. Looking about for economic wisdom, I came upon Gary's work. He was White, Weld's Chief Economist, as I recall. He was the only economist on The Street at the time who was forecasting a severe recession. Everyone else was forecasting protracted economic growth. Gary was right. The recession of the early 1970s was the worst recession to that point in the post-World War II period. He earned my respect.
Gary was bearish again regarding the U.S. economy in the early 1980s when his peers on The Street remained steadfastly bullish. Applying simple logic and historical precedents to the situation, Gary's view was again proven right. Others, sadly, were proven wrong.
I followed Gary from afar for nearly a decade. Having chosen in the early 1980s to set up my own firm that would focus on writing a daily commentary on the global capital markets, I chose to “screw my courage to the sticking point,” and called his office to request a meeting. To my great surprise and true delight, he said he'd be happy to meet with me. I remember to this day our meeting in a wonderful old building in lower Manhattan, where he graciously spent an hour or two talking about the markets, the economy, and his interest in Shakespeare, music, and history. From that point on, I've been an even greater fan of the man.
Thereafter I read, with delight and great expectations, his books on topics such as inflation and economics as well as his monthly newsletter to clients around the world . . . never to be disappointed. In all his work, Gary's wisdom is more than merely evident; his writings are cogent, rational, and, far more often than not, they are utterly “spot on.” Too, they are often witty.
Gary taught me the importance of technology shifts in matters few others could explain. For example, few today think about the Erie Canal, but in its time it was a huge shift for the better in the United States, opening up the western states to trade with the eastern seaboard in a manner previously unimagined. Gary's insights into why the wheat trade suddenly became an important part of the history of Buffalo, New York, which became perhaps the leading milling city in the then young United States, taught me why it was, through extension, important that Silicon Valley grew as it did in the 1970s, 1980s, and 1990s. He also taught me the importance of “good deflation” and “bad deflation.” And of the benefits of rising production and falling prices of goods and services during the growth of agriculture in the nineteenth century, and how that could be extra polated to technology today.
Gary taught me the importance of being an iconoclast in the world of economics, for it is he who sees with a different eye that survives the ebbs and flows of the investment world. He taught me the necessity of being away from The Street, where he and I could see with some sense of clarity what others might be seeing too closely and thus unclearly. He taught me the importance of keeping a long-term perspective, and the importance of having interests outside of Wall Street. So Gary has his bees. . . he's a well known beekeeper and gardener. . . he has his Shakespeare. . . he was once the Chairman of New Jersey Shakespeare Festival, a regional theater company. . . he has his music, and he putters around the house. And most importantly, he has his family. He's what, in the Midwest, we call “a good man.” This is high praise.
Over the years we've talked on the phone countless times, discussing the markets and viewing them with perspective. We've invested together, and we've sent clients to one another. We've had dinner; we've laughed; and all the while, I've learned far more from him than he's ever learned from me. In this new book, The Age of Deleveraging, Gary shares his newest ideas on the global economy, and I cannot recommend it strongly enough to anyone with even a tangential interest in how markets and economies work. I guarantee. . . and one is always warned never to guarantee anything in the markets. . . that you will come away from this book understanding how the United States and the global economy functions. You will be a better investor having read this book, and you will become enamored of this great gentleman.
To finish, let's not forget that despite his “Renaissance” visage, Gary has his feet in the modern world. After all, in years past he's entertained Keith Richards of the Rolling Stones and his family at his beach house on Fire Island. The tale of how this happened is another story for another time, but suffice it to say that when the world of the Rolling Stones and the world of Shakespeare can meet in the world of A. Gary Shilling, magic happens.
So, I wish you well in reading this excellent book and learning, as I have, what Gary offers. We are all the better. . . materially. . . for this.
Dennis Gartman
The Gartman Letter, L.C.
July 2010
Acknowledgments
This book is the result of literally decades of research and analysis, so many, many people have been involved over the years. Still, the actual writing of it took place from January through mid-April of 2010. The first months of the year are my “free time” for projects like this. From mid-April through October, my honeybees need lots of attention. So do my yard and gardens at our residence in Short Hills, New Jersey, and our beach house in Point O'Woods on Fire Island off the south coast of Long Island, New York. Then comes November and all the activities leading up to Thanksgiving and Christmas. So it's January 2 before I can catch my breath.
Assembling a book of this length and depth in three and a half months put a lot of strain on our organization, coming on top of an already hectic schedule. I'm delighted, however, that everyone worked long and hard, and with good cheer.
I'm especially indebted to our extremely able editor, Fred Rossi. In addition to the usual superb job he does in editing our monthly newsletter, Insight, and managing our growing distribution list, he typed and edited this book. I must confess that I broke into a museum and stole an ancient writing instrument called a pencil with which I wrote every word. But since I'm not completely antediluvian, it's a mechanical pencil. In any event, Fred did a magnificent job, as usual, in translating my chicken scratches on white lined pads into English—and did so in his usual calm, cheerful manner.
Colin Hatton, the senior man on our research team, also deserves my special thanks for much of the data, charts, and analysis in this book. Despite being only two years out of college, Colin has an excellent grasp of economic and financial data and a wonderful memory for the huge number of charts from which we selected the relatively few contained in this book. He also made a number of very helpful suggestions for the analyses that supported my arguments and forecasts. And Colin did it all with an unusual calmness and willingness to work long hours.
I also appreciate the work of Nestor Pura, a new research associate who nevertheless contributed to the analysis and charts. And I thank Jack Redmond, who took time from his investment advisory duties to unearth important financial data.
My most able assistant, Beth Grant, played an extremely critical role in keeping us all calm and focused on getting this book written on time and without the inefficiencies of personal blowups. How many times did Beth, in her extremely pleasant way, say, “Gary, how's the book coming?” I got the message loud and clear! Beth is the glue that keeps our firm together.
Finally, I thank my wife of almost 48 years, Peggy, for understanding the pressure I was under and for accepting the many evenings and weekends when I was not spending time with her, but bringing chapters of this book home from our offices and writing in the solitude of my den or on the dining room table. Even our female yellow Labrador retriever, Honey, seemed to understand the situation. Rather than bug me to go out and throw a tennis ball for her to retrieve, she lay down on the floor while I wrote, providing silent support and companionship.
Introduction
In 2007–2008, almost all investment categories suffered huge losses as the global financial crisis and worldwide recession unfolded. Stocks in almost every market worldwide; corporate, municipal, and junk bonds; commodities; residential and commercial real estate; foreign currencies; emerging market stocks and bonds; private equity; and most hedge funds bit the dust. Indeed, in 2008, the only winners were the traditional safe havens—Treasurys, the dollar, and gold.
But in response to massive government bailouts of financial institutions here and abroad and huge worldwide fiscal stimuli, those many depressed investments revived vigorously, starting in early 2009. So most investors believe that 2008 was simply a bad dream from which they've now awoken. We're returning to the world they knew and loved, with free-spending consumers supporting rapid economic growth, fueled by ample credit and backstopped by governments. After all, they reason, the recent experience proves not only that major financial institutions are too big to be allowed by governments to fail, but that the same is true for underwater homeowners. Monetary and fiscal largesse is so extensive, they believe, that economic overheating and serious inflation are the next major problems.
But the optimists don't seem to realize that the good life and rapid growth that started in the early 1980s was fueled by massive financial leveraging and excessive debt, first in the global financial sector, starting in the 1970s, and later among U.S. consumers. That leverage propelled the dot-com stock bubble in the late 1990s and then the housing bubble. But now those two sectors are being forced to delever and, in the process, are transferring their debts to governments and central banks.
This deleveraging will probably take a decade or more—and that's the good news. The ground to cover is so great that if it were traversed in a year or two, major economies would experience depressions worse than in the 1930s. This deleveraging and other forces will result in slow economic growth and probably deflation for many years. And as Japan has shown, these are difficult conditions to offset with monetary and fiscal policies.
The insidious reality is that this deleveraging doesn't occur in a straight line, but in a series of seemingly isolated events. After each, the feeling is that it's over, all may be well, but then follows the next crisis. When the subprime residential mortgage market collapsed in 2007, most thought it was a small, isolated sector. But then it spread to Wall Street with the implosion of two big Bear Stearns subprime-laden hedge funds in June of that year. Most hoped the Fed actions that summer had ended the crisis, but as the financial woes spread, Merrill Lynch suffered a shotgun wedding, major banks like Citigroup and Bank of America were on government life support, and Lehman went bankrupt in September 2008.
Then the third phase struck as U.S. consumers stopped buying in the fall of 2008 and the fourth, the global recession, coincided. The optimists hoped the $787 billion fiscal stimulus package in the United States and similar fiscal bailouts abroad would take care of all those problems, but were surprised by the eurozone crisis in late 2009 and early 2010. Nevertheless, that's just the fifth step in global deleveraging. The combination of the Teutonic north and the Club Med south under the common euro currency only worked with strong global growth driven by the debt explosion, but now that's over.
As I discuss in this book, further traumas on this deleveraging side of the long cycle lie ahead. They may include a crisis in U.S. commercial real estate that could exceed the one in housing, a collapse of what I believe is a Chinese house of cards, and a slow-motion train wreck in Japan.
I hope this book convinces you that the deleveraging process has years to go and that economic and financial markets have not returned to business as usual, at least not to the world of rapid growth supported by oversized and growing debt. If you agree with me, you'll appreciate the investment strategies that I see as appropriate for a decade of slow growth and deflation. In Chapter 11, I cover 12 investment sectors to sell or avoid, and in Chapter 12, I discuss 10 you should consider buying.
During the past fascinating decade, I played three roles. First, I was an eyewitness to history, watching speculation survive the Internet bubble collapse in the early 2000s due to massive monetary and fiscal stimuli, and then the spread to commodities, foreign currencies, emerging market stocks and bonds, hedge funds and private equity, and especially housing. I saw the housing and financial bubbles expand and then explode. I watched the fears of financial meltdown spur gigantic monetary and fiscal bailouts. I experienced the witch hunts that followed, the inevitable result of widespread losses and high unemployment.
Second, I've been a participant in this drama, not only chronicling it in our monthly Insight newsletter, but also continually warning of the impending collapses in the housing and financial bubbles. And I was involved through a very profitable year in 2008 for the portfolios we manage when all 13 of our investment strategies worked—most gratifying, in contrast to those who never acknowledged that those bubbles existed, much less could burst.
Third, I've participated as a forecaster in successfully foreseeing the expansion and then collapse of the housing and financial bubbles. More recently, my forecasts have focused on the continuing deleveraging that the bursting of those two bubbles commenced, and the resulting investment strategies for the next decade.
This book describes all three of these roles. I hope you find it enlightening, provocative, instructive, and at times amusing. It would probably have been more convincing had you read it in early 2009 in the depths of the recession and financial crisis, but it may be more useful today.
A. Gary Shilling
May 2010