Most Popular ArticlesJuly 7, 2009
Indeed, consumer retrenchment will impede economic recovery. Shilling recalled how consumers reduced their savings rates in the 1980s and 1990s, using their equity portfolios as a source of wealth, and then seamlessly shifted to borrowing against residential real estate. Now, the average individual with a mortgage and 50% equity at the market peak has seen his equity dwindle to 22% -- with a decline to the mid-teens likely to come.
Consumers today have no alternative but to save, Shilling said, and as a result will spend less for goods and services. Production cutbacks will result, causing layoffs and wage cuts, which in turn will lead to further cuts in spending.
“This is a vicious cycle that must be broken before we get out of this mess,” Shilling said.
Fiscal stimuli are the logical solution, but Shilling is not satisfied with the efforts so far. In the first $787 billion package passed by Congress, he said, only $200 billion went toward true stimulus spending – infrastructure projects, increases in unemployment benefits, or tax cuts. The remainder went toward the Obama administration’s social agenda, and will not lead to increased consumer spending.
A byproduct of reduced spending will be deflation, which has been a consistent theme in Shilling’s forecasts for the last decade. Declining commodity prices – led by decreases in the price of oil – and excess inventories will be the main drivers of deflation. Shilling said that, for the first time since the 1930s, employers have responded to the recession with wage cuts and shorter employee hours – instead of layoffs – and this, too, will fuel deflation.
Successful investing will hinge on positioning portfolios to defend against deflation. Traditionally, nominal bonds perform well in deflation, but Shilling warned that the rally in Treasury bonds is over. Instead, Shilling recommended focusing on sectors of the equity markets. Technology will be an “interesting play,” he said, especially among companies offering products to improve productivity. “In deflation, companies cannot raise prices to increase profits, so they must reduce costs,” he said, and productivity enhancing hardware and software does that.
Another area Shilling recommended was consumer staples. “If prices are coming down, consumers may cut or delay discretionary purchases like autos, cruises, appliances, and airline travel,” he said. But staples must be purchased regardless of price.
Shilling said to avoid companies with a lot of debt, as it will be more costly to service in a deflationary scenario. Consumers are already treating monthly payments on their own debt as discretionary, and Shilling advised against investing in the consumer finance industry.
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