GARY SHILLING: Here Are 10 Ways To Invest In The 'Grand Disconnect'

Gary Shilling

Photo: Robert Libetti/ Business Insider

The global investment environment continues to be dominated by deleveraging, according to famous economist Gary Shilling.He thinks we have at least another five years of deleveraging ahead of us, and until this era is done he expects average real GDP growth to be about 2 per cent.

At the same time investors are fixated on easy monetary policy. But this only has a temporary impact on stocks.

“This Grand Disconnect between robust security markets and subdued at best economic reality, combined with central bank-set low interest rates, has spawned many distortions and a zeal for yield that almost completely ignores financial risks,” according to Shilling.

Considering this, Shilling believes it is ‘risk on’ in 2013, but he cautions that his investment themes could “change dramatically” as the year progresses.

We drew on A. Gary Shilling’s Insights to walk through Shilling’s investment themes for the years.

We also added a bonus slide in which he points out the success and failures of his 2012 investment themes.

*Note: We corrected the time period for deleveraging.

Treasury bonds are still attractive and Shilling calls them his best investment to date.

'Most investors despise Treasury bonds, and not just because they fervently believe that serious inflation and leaping yields are inevitable. As we discussed in The Age of Deleveraging, stockholders inherently hate them. They say they don't understand Treasury bonds. But their quality has been unquestioned, at least until recently, and their prices rose promptly in 2011 after S&P downgraded them.'

Shilling says this theme has been his most profitable investment.

He expects 30-year bonds to appreciate more and says they are attractive because a) economic growth is likely to be slow in coming years b) the fed is determined to lower long term interest rates c) deflation is likely d) attractive to pension funds that are looking to match their long-term liabilities with similar assets e) they are a safe haven f) China's efforts to the cool the economy will probably cause a hard landing g) central banks continue to purchase treasuries.

Source: A Gary Shilling

So are high-quality income producing securities like companies that pay substantial dividends.

Stocks and other investments are unlikely to offer meaningful earnings gains and many institutional investors want cash payouts now.

In that light, companies that pay substantial and increasing dividends are coming into favour again since it shows investors that it is generating 'real earnings and real cash flow' and because significant dividend payers show that they are run in a prudent fashion. Investment grade corporate bonds also look attractive.

Source: A Gary Shilling

Small luxuries are attractive because consumers still buy the best of what they can afford.

When consumers are on a budget they still like to buy the best of what they can afford even in the low-price category.

'We think manufacturers and retailers that can adapt to the demand for small luxuries will continue to be winners in the current environment.' In 2012, their index of companies in premium beer and liquors, perfumes, luxury clothing, accessories and home products was up 18 per cent.

Source: A Gary Shilling

Consumer staples and foods that are necessities will do well.

Consumer staples and certain foods like laundry detergent or bread are necessities that consumers buy in good times and bad, and 'we believe their producers equities will remain attractive'.

Declining commodity prices are also helping the profit margins of producers and retailers of such products. Consumer downgrades are expected to continue and among retailers the biggest winners will likely continue to be dollar stores.

Source: A Gary Shilling

The dollar should appreciate, especially against the yen.

The U.S. dollar should rise as other nations devalue their currencies and widely considered a safe haven, it should also benefit when investors go from a risk on to a risk off environment.

Commodity currencies like the Canadian and Australian dollars have risen against the dollar, but the yen hasn't in anticipation that Shinzo Abe would add stimulus and further devalue the yen.

There are three ways to play the Abe government's policies, short the yen, buy Japanese stocks or sell the Japanese government bond.

Source: A Gary Shilling

Selected health care providers and medical office buildings are still attractive because of America's ageing population.

That Americans don't directly pay for healthcare, that other than deductibles and co-pays there is no limit on healthcare usage, and that medical providers have incentives to perform extra work and boost their incomes in pay for service plans leads Shilling to say 'three major features of the current system almost guarantee explosive growth and maximum cost'.

Moreover, the demand for medical services is set to balloon since the population is ageing rapidly, technological advances are increasing demand for more medical services, 32 million more Americans will be covered under the 2010 health care law by 2019.

Medical office buildings also offer good investment opportunity after demand was projected to increase 19 per cent by 2019, some of it because of the new law and the rest because of population growth.

Source: A Gary Shilling

Rental apartments benefit as couples no longer see homes as a good investment.

'Rental apartments will continue to benefit from the separation that Americans are beginning to make between their abodes and their investments. …At the front end of the life cycle, young couples may decide that because houses are no longer a great investment, there's no reason to strain their financial, physical and emotional resources to buy big, expensive houses as soon as possible.'

Source: A Gary Shilling

Productivity enhancers like tech companies remain attractive as businesses try and cut costs.

Productivity enhancers will continue to benefit as companies continue to come under pressure to lower costs.

'labour cost-cutting has been in vogue in recent years, but does have its limits. So anything -- high tech, low tech, no tech -- that helps customers reduce costs and promote productivity will be in demand.'

Source: A Gary Shilling

North American energy producers ex-renewables look good as American tries to become energy independent.

North American energy looks attractive because of the 'national resolve to reduce imports from unreliable foreign sources'.

His top picks are natural gas producers, pipelines, oil sands, energy services, oil producers, nuclear energy, shale oil and gas, and possibly coal. He is however sceptical of renewable energy because of its dependence on government subsidies.

Source: A Gary Shilling

Commodities continue to be unattractive and prices should drop.

Shilling says commodity prices should continue to drop in 2013 because of weakness in the global economy and rising inventories.

Source: A Gary Shilling

Bonus - Investment themes that did and didn't work for Shilling in 2012.

Now look at JP Morgan's guide to the markets for the first quarter...

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