A. Gary Shilling - Six Realities In An Age Of Deleveraging

Tyler Durden's picture

Submitted by Lance Roberts of Street Talk Live blog,

In Part III of Lance's series of reports from the 10th annual Strategic Investment Conference, presented Altegris Investments and John Mauldin, the question of how to invest during a deleveraging cycle is addressed by A. Gary Shilling, Ph.D.  Dr. Shilling is the President of A. Gary Shilling & Co., an investment manager, Forbes and Bloomberg columnist and author - Mr. Shilling's list of credentials is long and impressive.  His most recent book "The Age Of Deleveraging: Investment Strategies In A Slow Growth Economy" is a must read.  Here are his views on what to watch out for and how to invest in our current economic cycle.

Six Fundamental Realities

  • Private Sector Deleveraging And Government Policy Responses
  • Rising Protectionism
  • Grand Disconnect Between Markets And Economy
  • Zeal For Yield
  • End Of Export Driven Economies
  • Equities Are Vulnerable

Private Sector Deleveraging And Government Policy Responses

Household deleveraging is far from over. There is most likely at least 5 more years to go. However, it could be longer given the magnitude of the debt bubble. The offset of the household deleveraging has been the leveraging up of the Federal government.

The flip side of household leverage is the personal saving rates. The decline in the savings rate from the 1980’s to 2000 was a major boost to economic growth. That has now changed as savings rate are now slowly increasing and acting as a drag on growth.

However, American’s are not saving voluntarily. American’s have been trained to spend as long as credit is readily available. However, credit is no longer available. Furthermore, there is an implicit mistrust of stocks which is a huge change from the 90’s when stocks were believed to be a source of wealth creation limiting the need to save.    

My forecast for GDP growth going forward is that it will remain mired around 2%.

The response to the stalled economic environment and deleveraging cycle has been massive government interventions.  The Fed’s original program of zero interest rates have failed to promote borrowing. The next step was unprecedented Quantitative Easing.

The Fed’s dual mandate is full employment, currently targeted at 6.5%, and price stability (inflation) around 2%.  The Fed has been very clear that the current QE programs are directly tied to these targets.

However, monetary policy is a very blunt instrument, but the Fed believes that it will work within a 5 step process.

  1. The Fed buys treasuries and mortgage bonds out of the market.
  2. The increase in liquidity is then reinvested into the equity market.
  3. The rise in asset prices creates a wealth effect for consumers.
  4. With stronger confidence consumers spend more which creates demand on businesses.
  5. The increase in demand leads to job creation.

The problem is that there is little evidence that Q.E. programs are fulfilling their intended role.

History is not a controlled experiment. There is no way to tell what would have really happened had the Fed not intervened after the financial crisis.

However, what we can absolutely measure, is the impact of the Fed’s activities on the economy. If we measure the increase in real GDP for each dollar of increase in debt we find that it has been close to nil. From 2001 through the end of Q2-2012 – we find that there has been only a 0.08% increase in real GDP per dollar of increase in debt.  

While the economy has failed to ignite - there has been a sharp surge in market capitalization as a percentage of nominal GDP.   Currently at levels well above the long term average it is unlikely that this is the beginning of the next great secular bull market.

The bottom line is that despite trillions of dollars of Federal Reserve interventions there has been very little impact on the real economy. This is because there has been very little follow on effect from the massive increases in excess reserves.   Historically required reserves have remained fairly close to the level of excess reserves. However, today, excess reserves are running roughly $1.7 trillion above the level of required reserves. Liquidity remains trapped which is why there is no velocity of money in the economy.

Growing Protectionism

The problem today is that everybody wants to increase exports to boost their respective economies - but no one wants to, or is able to, buy. This has pushed countries into the need to take more drastic actions to stabilize and boost their economies.   This has led to currency devaluation schemes.

Japan is the poster child to currency devaluation.   They have gone “all in” to debase their currency in hopes that they will create some inflation. For Japan it is “go big or go home.”

It is important to note that NO ONE ever initiates currency devaluation – they are just trying to get back to even.  

Currently, the head of the central bank in Japan, has the backing of the country. This will allow him to operate and continue his stimulative actions. The tipping point will be when he loses this approval.

However, while Japan is currently happy with their direction, other countries are not. Eventually there will be a reprisal.

The Great Disconnect

“Don’t worry about a thing as long as the Fed is inflating assets and the economy is in the tank.”

Nobody wants to end the current Q.E. programs.  What it will take is an economic shock of some magnitude. What type of shock it will be, and when it will occur, are the only questions?

Here is the simple truth: Stocks will eventually revert to the fundamentals of the economy. Such a reversion will devastate most investors that are unhedged for that eventuality.

Zeal For Yield

The chase for yield has reached excessive levels. Despite the rising risks individuals continue to ignore the fundamentals and reach for ever increasing levels of yield.

Junk bonds, emerging market debt and bank loans are at record low levels in yield. The yield on stocks and bonds are equal for the first time decades. This is an indication of a late stage bull market. It is also one that has historically ended badly for investors.

End of Export Driven Growth In Developing Countries.

The demand for exports is slowing as the major developed countries are weak and demand slackens.

(Note: This was seen in the latest trade deficit report as imports for the U.S. plunged sharply last month. In other words the demand for products from other exporters is slowing which negatively impacts their economies.)

As Jeff Gundlach discussed earlier – China’s growth rate is slowing. However, no run really trusts the data coming out of China. It takes China 18 days from the end of the quarter to report GDP. It takes the U.S. 28 days.   China never revises their data subsequent to that first report while the U.S. revises its data two more times over a 90 day period. The data is extremely unreliable. For instance, how do you have a flat manufacturing report coming out of China, as measured by Markit PMI, when they supposedly have a 7.7% GDP growth? That simply does not add up.

Going forward emerging economies are focused on creating internal growth to offset the drag from slowing export growth. This will likely lead to problems.

Equities Are Vulnerable

We are still within a secular BEAR market that begin in 2000 with P/E ratios still contained within a declining trend. Despite media commentary to the contrary - this time is likely not different.

In order for valuations just to return to the long term average they would have to decline by 27.5% from current levels. However, the reality is that valuation reversions always exceed the long term mean.

Furthermore, corporate profits have only soared due to declining labor costs and increased productivity. The problem now is that there is an inability to slash costs and increase productivity at levels that can offset the decline in operating earnings and revenue.

This makes equities susceptible to a large reversion at some point in the future.

2013 Investment Themes

“Economists are like lookouts at the house of ill-repute.   They are kept away from the action but good to have when the cops arrive.”

The risk on trade is alive and well - but will not last forever. Therefore, the following is what I find attractive and unattractive in the current environment.


  • Treasury Bonds
  • Quality Bonds And Dividend Stocks.
  • Small Luxuries
  • Staples And Food.
  • Doll Vs Yen, Long Nikkei
  • Selected Healthcare Providers And Medical Office Buildings
  • Productivity Enhancers – Things That Help Businesses Lower Costs
  • North American Energy Producers Excluding Renewables


  • Developed Country Stocks
  • Homebuilders And Related Companies
  • Your House
  • Big Ticket Consumer Discretionary Stocks
  • Consumer Lenders
  • Selected Banks
  • Junk Securities
  • Developing Country Bonds And Stocks
  • Commodities
  • Old-Tech Capital Equipment Producers


Austerity Or Stimulus – What Should We Be Doing?

If you don’t get austerity when things are tough you will never get it.   This is the problem in Germany.

In the U.S. – Congress has it completely backwards.   They should be working on structural deficits rather than fiscal deficits. Change retirement ages, etc. rather than trying to inflate assets.

GDP less inventories is much weaker.   Inventories are a residual of activity and small changes on either end have a big impact on the economic figure.  

What Happens?

The great disconnect will reconnect over the next couple of years which will negatively impact long only investors.

The Fed Reserve – Does The Fed Have To Exit?

That is an interesting point. With slow growth, which will continue due to the ongoing deleveraging cycle for another 5 years, it is likely that the Fed will not try and exit.   However, when the economy begins to reach higher levels of growth in the future the excess reserves will begin to flow into the system.   If the Fed doesn’t exit from their policies when that occurs the impact of inflation could be severe.

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lewy14's picture

Shiller gonna shill.

EDIT: Crap, I was too quick on the draw. Shilling, not Shiller. My bad. Damn, and I'd been sitting on that one waiting for a Shiller headline.

Jam Akin's picture

Attractive?  Treasury Bonds?  What a crock of horseshit.

markmotive's picture

Massive Japanese money-printing and the Yen carry trade is supporting US Treasury yields.


DoChenRollingBearing's picture

After I received a "doom porn" email from one member of our group that stays in touch with each other re TEOTWAWKI and exfiltrating the USA, I sent him a response (edited to preserve anonymity):

"Outgoing Email re Preparation"


Precious's picture

Ahh yes Mr. Shilling. Apply reason. That might work!

It seems more likely however, that positive returns generally avail to those who possess the biggest guns.

Herd Redirection Committee's picture

Does anyone actually BELIEVE that the Fed believes this sh*t:

  • The rise in asset prices creates a wealth effect for consumers.
  • With stronger confidence consumers spend more which creates demand on businesses.

OK, so lets take a closer look. Who will actually experience this hypothetical wealth effect?  The wealthy, of course, those exposed to bonds, financial stocks, the stock market.  So, by definition, a very small segment of the population will not only experience a 'wealth effect', they are literally becoming more wealthy!  Fed policy benefits a small segment of the populace, and we think this is an accident, or incompetence?

So on to the next point, which consumers will have stronger confidence?  Only those who experienced the 'wealth effect'. 

The problem w/ the economy, besides its very structure (fractional reserve banking, usury, w/ fiat currency), is that those with the most wealth could not possibly spend it all, while those who would spend the money if they had it, are broke. 

If you were able to do a historical analysis, I bet you the inequality of wealth now is greater than it was in feudal times.

DoChenRollingBearing's picture

@ the Bearing Guy

Hey!  I picked up a troll!  How cool is that?  Maybe my blog has arrived!

Quinvarius's picture

Here is the thing.  No matter what the problem, the gov can print money and buy their way out of it.  Grid down.  Banks dying.  War.  It doesn't matter.  Massive inflation is the biggest concern and the future reality.  Every other problem is just a cause of money printing.  I would use the term hyperinflation, but because so many people try to define it as X price increase over Y time period, I am not going to bother going into that debate.  The USD is going to lose the next 90% of its purchaseing power over 4X faster than it lost the first 90 percent.  The latest printfest/debtfest has kicked us 4 decades into the future on money creation.  We were blowing up the money supply 5.3 percent every year between 1981 and 2008.  Just to maintain the status quo the new debt and monetary needs at that level, the US will be creating at least 215 billion a year if QE ends in 2014 at a 4 trillion monetray base.  However, based on debt levels and funding needs, I would say it will be closer to 900 billion a year minimum.

I would say your friend with PMs will do okay.  I wouldn't worry too much about max max chaos.  I would worry about the kind of scarcity we see in bullets and PMs coming in waves over the food and energy markets.  Fake pricing set by banks and government causes that. 

WhiteNight123129's picture

Yes and Japanese bonds are "attractive" too.


markmotive's picture

It doesn't matter what's 'right' or 'wrong'. What matters is that forces with an infinite supply of money are currently supporting the US and Japanese bond markets.

It will work until it doesn't.

lewy14's picture

The thing that will destabilize the system now is... growth itself. 

So after deleveraging? Why worry... there will be no "after deleveraging".

There are plenty of ways policy can destroy growth. They are manifest now.

The combination of (deflationary) growth-inhibiting government policy and (inflationary) QE monetary policy creates rough stability - with an every increasing share of state ownership of, and state control over, the "economy".

If you're a connected statist oligarch, what's not to like?

What I'm not seeing is any potential for a "reset" event. This setup could be stable plenty long enough for the PTB to become permanently entrenched. 

Seer's picture

Sometimes it feels good to beat a dead horse, but at the end of the day you only beat on a dead horse...

Most fail to understand that growth, due to insufficient NATURAL capital, is what is killing everything.  There is NOTHING that anyone can do about this.  Any attempts to force growth only guarantees another bubble.

Perpetual growth on a finite planet is NOT possible.  As much as I dislike govt, govt has zero control over this fact.

noless's picture

Over harvesting of ocean wildlife seriously concerns me. If you wanna talk about systemic collapse, look no further than a collapse in the global food chain, some might make it out chewing on irradiated leather, but seriously, id rather not.

If humans don't scale back extraction it places extreme pressure on the remaining species of the planet, i still wish i'd ever been able to taste a passenger pigeon..

So yeah.

Hail Spode's picture

How long can it be stable when fewer and fewer are growing beans and more and more are connected to redistributing the beans that others grow?  

lewy14's picture

Beans no longer imply beanmakers.

U4 eee aaa's picture

And they aren't even magic beans

Hail Spode's picture

How long can it be stable when fewer and fewer are growing beans and more and more are connected to redistributing the beans that others grow?  

mess nonster's picture

Due to the magic of petroleum, only 2 people out of 100 grow beans in the US. Peak Oil means that bean production is bound to plummet, and with it the population of non-bean-producers.

Arable land, bitchez.

Work ethic, bitchez.

Don't eat the seed corn (beans), bitchez!

Gazooks's picture

permenently entrenched = cratered


the economic scenario relates well to the recent impact of shifted cargo in the belly of a 747 unable to sustain altitude at pitch of assent


the closer to stall is the adrenaline rush of inevitable fireball fate


shill ing will sift rubble

fonzannoon's picture

"Household deleveraging is far from over. There is most likely at least 5 more years to go"

and then what? Thing are just awesome?

Tyler with all the respect in the world....forget shilling and everyone else and post the real vid of the day and let's all have a drink and put this fked up day to bed.


Room 101's picture

I agree.  Another fucked up day.  A drinking thread is in order. Put me down for a frosty one.  Hell, I'll buy all you ladies and gentlebitchez a round. 

fonzannoon's picture

knukles sent this to me a year ago as a good drinking song. I listen to it all the time now. Have a cold one and enjoy.


otto skorzeny's picture

Horst Wessel Lied and an Englberg Pilsner. Also-take  Mylute to win tomorrow in a sloppy Derby.

Jim in MN's picture


Metallica, 'Whiskey in the Jar' silly video though great song...find another band doing it if you want it more Irish-y

otto skorzeny's picture

metallica was great pre-Lars acting like a d-bag about Napster.

Prometheus418's picture

Here's another for ya, fonzannoon-

You may not like it better than the Waterboys, but they definately live in the same neighborhood, and if you're like me, variety is the spice of life.



shovelhead's picture

I like it.

Knucks got good taste. I'll have to see if it works as well with a finely cured Santa Marta.

Freddie's picture

I like Tyler(s) but where is the story tonight on Nigel Farage and UKIP's big wins in the UK? 

otto skorzeny's picture

freddie- if you think politicians are the solution to anything you need professional help.

U4 eee aaa's picture

If the leaders of the rebellion are true patriots, it only takes about two weeks for the elites to get to them(and the elites can take their time). Soon they are spouting the same betrayalspeak that the regular political pets are spewing

It will take creative destruction and change agents to change our world

Herd Redirection Committee's picture

There's a lot of ways.  You can blackmail, you can extort, you can threaten, preferably vulnerable family members.  YOu can bribe, thats a known favorite.  Worse come to worse you will be Spitzer'd, or Kennedy'd.

CrazyCooter's picture

Excellent link. I cashed out everything last year due to taxes. I got a small bank balance and some debts. I have a bid in at an auction for a 10 yr old truck. If I win it, I am selling my 2011 vehicle and using the equity to almost eliminate credit card debt. At that point, I will be down to a rent house that is cash flow neutral with a tenant.

I very much look forward to those pay days with disposable PM bennie bucks to spend. My wife is VN, so I may very well park some dollars over there or even buy some RE just to spread it around.

I got job security and am improving my marketable skills, so I can ride the ride, but this is going to be real tough for a lot of folks. It scares me to think I am going to "retire" in 20+ years; all hell will have broke loose by then and the big oil fields will be dried up. But, I think I can hold onto a job during that time, so we will see.



Seer's picture

Wow!  A 10 yr-old truck!  Mine's 20 yrs-old! (only new vehicle I ever bought was a lawn tractor for my wife!)

I've never owned a credit card.  If something is really worth having then either pay cash or take out an actual loan.

Bought land (and a house) a couple of years ago and am working on farming skills.

It's easier to think of retirement if you don't think about it.  That is, don't expect it.  I'm going with the premise that there won't really be any such thing in the future, and, really, I'm OK with that (not like I could "retire" anyway).  If your wife is VN then she can probably tell you that "retirement" isn't exactly a household term there: my wife is from the Philippines (old school) and she KNOWS this to be the case; makes it a lot easier, cuts down on fantasy-land pressures.  Best way to look at things is to seek to be as productive as you can for as long as you can.

CrazyCooter's picture

The secret to an old vehicle is maintenance. If you know its been taken care of, it makes sense to play that game. Mileage is another big factor. Ubiquity in parts is the rest.

Being as no one really gets educated about money/credit, its a process once the light bulb goes on. Kind of my situation. If I had ZH in '06, I would be in a VASTLY different place. But I didn't find ZH until after I bought a house and divorced. Can't live in the past, so just keeping my boots on and moving in the right direction.

SE Asian women are the best IMHO. Frugal, no bull shit gals that don't suffer much BS. Mine has a BS in Economics and Engineering. She tries to kill me with food. I think the only complaint is she doesn't like me to drink beer. Like a damn bull dog with the subject. I get a six pack a week and if I save em up to drink, she gives me grief. LOL!



U4 eee aaa's picture

Anyone who spends more than 5 or 10K on a vehicle is just boasting.

They are designed to get you from point A to point B. They are not designed to impress your neighbor. There might be a benefit in getting a mate but once you are married you don't need it for that.

noless's picture

5k sounds kind of steep to me, but then again, I'm fine driving something with a warn clutch and no resale value.. I wonder sometimes what it's like to drive a new car. I'm serious.

U4 eee aaa's picture

Some folks don't know how to fix 'em. Mine cost $3,000 and I've probably put $500 or so work into it. It gets me to a from work reliably every day. I'm not sure I'd take it on a long road trip but it's a Toyota so it would probably do all right

roadhazard's picture

I've got a 95' Chevy 4x4 pu. On the other hand I'm getting a dozen brand new 2013 chickens Today.

GubbermintWorker's picture

Peter has been laughed at before when he was spot on, if I remember correctly.

otto skorzeny's picture

the Fed has no exit strategy - they'll ride this bomb down like Major Kong in Dr Strangelove.

Seer's picture

Much of what he says about how things are working (or not, as is the case) is good.  His "solutions," however, are not: this is pretty much standard fare for nearly everyone.  Treasuries?  Huh?

"However, when the economy begins to reach higher levels of growth in the future"

And THERE it is!  The PREMISE.  They ALL do it, slip in a basic premise on which they heap everything else, and never can we really engage in questioning the premise!  "Housing prices ALWAYS go up."  "We will ALWAYS have growth."

YHC-FTSE's picture

Ridiculous premise, but as we all know a Ponzi by definition has to add more suckers to maintain the illusion of working. Adding new suckers = growth = debt maintenance. 

This might be an unpopular prediction, but I think with the appointment of Watt at Freddie and Fannie, and the desperate systematic need for High Quality Assets,  there will be a concerted effort this year to sign up as many mortgages as possible, and real estate is going to be pimped/pumped to highs until we get the whole subprime collapse all over again. Cash buyers have rolled the ball, and the Fed will want to keep the momentum. 

cherry picker's picture


From previous comments you have written, I assume you're a young fella, seem to be intelligent, articulate and have a grasp of things.

The ball is in your court.  If we ever wan't to achieve hope and change, you'll have to do it.  My generation, the white haired waiting for the pine box types are too addicted to SSI, free medical and so on.  It is my generation's life blood, but we have had our time.  I am not like that, never asked and won't ask .gov for anything, although I contributed.  Too much pride in this old body, would rather starve first.

You are going to make mistakes, that's OK.  Just don't sell your soul to the 1%, don't let them seduce you with hookers, blow and coin and don't let them threaten you.  If you can do that and if there are others out there with the same mind as you, we may have a fighting chance for a sorely needed correction.


YHC-FTSE's picture

You meet the sweetest, nicest, wise people on rare occasions,  and this is one of them. Thank you.

noless's picture

Agree on RE. They're gonna ride that bitch, haven't looked in a while as i no longer have the means, but the subliminal is a definite push towards home buying for the young. My experience was a constant drought of property in my range, even as i was saving, putting me in a place to buy something substantially more than i needed, without the option that i wanted, ended up renting because all the shit i could have potentially afforded was bought and set up as rentals, yay easy money i guess.

Take away: total control of markets leaves you either indebted or enslaved, generally both as synonyms.

Petrus Romanus's picture

I would have to say that Mr Shilling is a bit of a CUNT!

 Where does this cocksucker see deleveraging? I hope this shill is raped by a pigmy.