Most Popular ArticlesNovember 24, 2009
Implications for investors
If you believe Shilling’s forecast of slow growth and deflation, then you should avoid the following types of investments:
1. Industries dependent on big-ticket consumer discretionary spending (e.g., automobiles, appliances, and travel). These expenditures are too easily delayed in a deflationary environment.
2. Companies with below-average revenue growth, high fixed costs, and large amounts of debt. These companies have less flexibility to raise prices, and the cost of servicing their debt increases with deflation.
3. "Old technology" companies that manufacture capital equipment. Capital equipment spending will be depressed until capacity utilization increases.
- Art and collectibles. These rise with inflation and suffer with deflation.
- Banks and financial institutions. They will be hurt by continued deleveraging and by a flattening of the yield curve as short-term rates eventually increase.
- Consumer finance-based companies. Consumers will use less credit, and delinquencies and defaults will increase.
- Junk bonds. Spreads in this sector no longer compensate investors for the risk of default.
- Conventional home builders. They will suffer until the excess housing inventory is absorbed.
- Commercial real estate. This sector suffers from overcapacity, particularly in hotels and shopping malls.
- Commodities. Commodity prices will remain depressed under deflation, and Shilling said commodities do not command status as an asset class.
Shilling identified nine areas as buy candidates:
- Dividend-paying stocks. With 2% projected real GDP growth and 2% deflation, Shilling forecasts no nominal GDP growth. Since corporate profits historically correlate with nominal GDP growth, Shilling expects the bulk of equity returns to be in dividends rather than capital gains.
- High-quality bonds, especially Treasury bonds. Shilling forecasts 30-year rates to decline from 4.3% to 3%.
- The dollar. The dollar’s decline will end as its importance as a safe haven increases.
- North American energy. The US and Canadian energy industries will benefit from political stability relative to other parts of the world and from renewable energy policy initiatives.
- Consumer staples and food. Deflation and slow growth will not impede consumer purchases of necessities, such as toothpaste.
- Investment advice and asset management. Growth will come because consumers need help with financial advice, provided that fees are commensurate with the value provided.
- Factory-built housing and rental apartments. These sectors will benefit as consumers no longer think of housing as an investment.
- Healthcare. This will benefit from Obama’s initiatives and from its ability to employ people with diverse skills and backgrounds.
- Productivity enhancers. Without inflation pushing up revenues, reducing costs is the way companies will improve profits.
Shilling did not say whether he believed industries in the above sectors were over- or undervalued, only that their growth rates would diverge from historical averages.
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