Thursday, July 11, 2019

The US Dollar is a Safe Haven | Gary Shilling interview with ThinkAdvisor

Gary Shilling interview with ThinkAdvisor 

THINKADVISOR: How deep a recession do you predict?

GARY SHILLING: An average recession. I don’t see a big financial crisis like the subprime mortgage collapse, the dot-com blowup or the 1973-1975 recession, which was the second deepest since the 1930s. But this one would probably be a substantial decline from Christmas Eve 2018, when the market declined almost 20% from its peak in early October.

Are President Trump’s chaotic White House and his other challenges a cause of the recession that you perceive?

Those are contributing to a recession. Uncertainty seems to be his strategy. It seems he wants to keep everybody off balance. We see that particularly in the trade area. It holds back spending and investing. And, of course, there’s the prospect of an all-out trade war with China. The issue isn’t [just] a trade imbalance. It’s got a lot to do with China’s hopes of becoming an even more powerful country than the U.S. Trump realizes that the way they’re trying to do that is by using Western technology, and he doesn’t want to see that happen.

But you’re saying that a recession has probably started.

Yes, and for incumbents in Congress or in the White House to get re-elected in the midst of a recession, or even early in the aftermath, is very difficult.

Still, uncertainty isn’t good for the stock market, right?

It isn’t. But, apparently, Trump isn’t yet concerned enough that the stock market is going to sink and kill his chances of re-election next year.

Please discuss corporate earnings’ role in your recession scenario.

They’re already weakening, as you know. The earnings’ estimates are for declines of 5% year over year. But that’s from Wall Street analysts who are paid to be bullish. So you can well imagine that earnings are going to be weaker than that. But this hasn’t hit home yet.

What do you mean?

Investors are preoccupied with the Fed. People think if the Fed eases, it’s a wonderful world.


Because the Fed fueled the long bull stock market. Investors are therefore conditioned to believe that the Fed is the only game in town, and you don’t give a damn [about other indicators]. Why is the Fed talking about cutting rates? Because they’re worried about the economy. But people don’t see that. They just say, “Oh, the Fed cuts rates, and everything is dandy.”

What’s your forecast, then, for interest rates?

We’re looking at lower inflation, which is very favorable to Treasuries. So I think we’re going to see distinctly lower rates for Treasuries and investment-grade corporate [bonds]. We’re headed for 1% on the 10-year Treasury and 2% on the 30-year within a year. A recession makes Treasuries a safe haven, and it means that credit demand elsewhere dries up. We’ve had a wholesale rush of individual investors into Treasuries.

What are the main indicators telling you that a recession has likely already begun?

You’re getting a host of indicators that, while they don’t guarantee a recession, when you put them on top of the Fed’s earlier tightening, probably makes it an odds-on bet. [They include] weakness in housing; decline in industrial production; the New York Fed’s recession indicator now up to 30, which is the level that past recessions have started; declines in durable goods orders and capital spending. Also, surveys show that jobs aren’t as plentiful as they were.

If you’d written your July Insight analysis after the Labor Department issued its favorable June employment report last Friday, instead of before, would you still have said that a recession is probably underway?

Yes. You can make a case that the economy peaked back in late winter or early spring. There are so many indicators we’ve been talking about in recent months that are pointing to recession. June [jobs number] was a rebound from the very low number in May; but March, April and May were revised down, after January and February were revised up. Downward revisions are very strong indicators of weakness.

Did the June employment report show any weak areas?

One of the few was retail. The number 1 reason is that consumer spending is slowing: People had been reducing their saving rate to fund their spending. But starting about two quarters ago, they certainly shifted gears by apparently deciding they’ve had enough debt and didn’t have the funds to continue heavy spending. So the saving rate has picked up. But they were living on borrowed time because when spending is growing faster than income, that cannot continue indefinitely. Secondly, [the retail number was weak] because of the Amazon [online purchasing] effect.

Investors seem to be quite fearful and worried about the stock market now.

They should be. It’s very expensive.

How should they proceed to invest?

Do what they’re doing: Be very cautious on stocks. The portfolios we manage don’t have many equities. You need an anchor to windward: so we’re invested in defensive stocks — consumer staples, utilities, health care.

And of course you own Treasury bonds. What’s your strategy?

They still make sense. People say, “Oh, the yield is low.” But I’ve never, never, never bought Treasuries for a yield. I couldn’t care less what the yield is as long as it’s going down. I buy them for the same reason most people buy stocks: appreciation.

Do you continue to have a big cash position?

Yes, but not as large as it was because we’ve increased our Treasury position, particularly; and we’re also long the dollar. The dollar is a safe haven.

Can anything be done now to avoid the recession that you see from deepening?

At this point, I don’t think so.


Thursday, June 27, 2019

We might already be in a recession in USA

Gary Shilling in an interview with Realvision

"I think we’re probably already in a recession but I think it will probably be a run-of-the-mill affair, which means real GDP would decline 1.5% to 2%, not the 3.5% to 4% you had in the very serious recessions."

Monday, June 3, 2019

US China Trade War could be Deflationary rather than Inflationary

Usually Import Tarriffs would cause consumer prices for the affected goods and services to go up. Gary Shilling in a Bloomberg article talks about why the USA- China Trade War could be Deflationary instead of Inflationary.

The trade war between the U.S and China shows no signs of abating, with each side boosting tariff levels. From the U.S. perspective, such tariffs might appear inflationary, as the levies are added to the costs of imports and passed on to their ultimate users. A 25% jump in the cost of all $575 billion in goods imported from China, even without markups and follow-on increases from competing U.S. producers, would add about 1% to consumer prices.

In reality, however, import tariffs and the whole trade war are more likely to be deflationary as governments, businesses and consumers here and abroad take offsetting actions and the conflict takes its toll on global economic growth. News reports say U.S. importers are switching to suppliers in more-certain countries such as Vietnam, Thailand, Pakistan and Taiwan. This is costly and disruptive, but has been underway ever since Trump’s 2016 election victory.

Enphase Energy and SolarEdge Technologies, which control most of the market for residential inverters that convert solar DC current to AC, are planning to open plants in Mexico and Vietnam, according to the Wall Street Journal. Telecom gear producer Ericsson is preparing to shift some manufacturing operations out of China to the U.S., Estonia, Brazil and Mexico. Taiwan-based AsusTex Computer is moving some production to Taiwan and Vietnam from China. Stanley Black & Decker plans to move production of Craftsman wrenches back to the U.S. from China, the Wall Street Journal also reports.

More modern equipment such as robots and faster-forging presses will help boost output about 25% above the older machines used in China and keep production costs about the same. Whirlpool is moving production of some small KitchenAid appliances from China to the U.S.

The permanent loss of an important export sector does, of course, put pressure on China to come to terms with the U.S. on trade. At the same time, Chinese retaliation is retarded by its dependence on the U.S. for key imports. Only about 14% of China’s semiconductors come from domestic suppliers, and it imported $6.7 billion in chips from the U.S. last year. Also, U.S. chipmakers already are subject to a 25% import duty from China and, in response, are reported to be routing their products to China indirectly through third countries.

With U.S. consumer spending slowing after a disappointing holiday season at the end of 2018, many importers and retailers are being forced to shave margins to avoid passing on the full cost of the new tariffs. Unwanted retail inventories are rising. Consumer discretionary goods merchants, excluding internet retailers, were already expected to suffer a 5.2% contraction in profit margins, according to Bank of America Merrill Lynch analysts. A future squeeze on margins is likely since retailers can’t raise prices to pass on tariffs without losing sales. A 2.3% average price rise would be needed to offset the 25% tariffs. If they can’t raise prices, tariffs could compress earnings by 39% on average this year. Home Depot plans to spread cost increases over more items to limit the impact on sales.

Consumers simply refuse to accept price increases. Attempts are met by switches to lower-price retailers, online sources and house brands. In fact, the Fed is worried that expectations of low inflation or deflation retard spending as potential buyers wait to purchase. The Federal Reserve Bank of New York’s April Survey of Consumer Expectations shows that the public’s outlook for inflation fell to the lowest since late 2017. Fed Chair Jerome Powell said earlier this month that “inflation expectations over time could be pulled down and that could put downward pressure on inflation and make it harder for us to react to downturns.”

A stronger dollar is also depressing prices of U.S. imports. Prices of Chinese imports fell 1.1% in April from a year earlier, the steepest drop in two years. Declining import prices forced domestic producers to follow suit and is another offset to high import tariffs. U.S. import prices overall have recently declined. But so, too, have export prices, which points to a final reason that the tariff increases and the trade war with China is likely to prove more deflationary than inflationary: the resulting downward pressure on already-slowing global economic growth. The International Monetary Fund forecasts worldwide GDP growth of 3.3% this year and 3.6% in 2020, compared with its estimate in October of 3.7% growth in both 2019 and 2020.

If you’re worried about the Fed overreacting to trade war-induced inflation, relax. The deflationary implications of the trade imbroglio are more likely to speed up the Fed’s timetable for an interest rate cut.

Wednesday, May 1, 2019

Tax increases may encourage residents to flee High Tax states in USA

US states with High Taxes may be hurting themselves. Gary Shilling talks about a trend where high earners in high tax states leave for lower taxed states via Bloomberg

The U.S. Tax Cuts and Jobs Act enacted at the very end of 2017, which limited the deduction of state and local taxes to $10,000, has focused attention on the vast differences among municipal levies. It also provided an incentive for high earners to leave high-tax states such as New York for lower-tax climes including Florida and New Mexico in a trend that will only intensify.

From 2011 through 2015, New York was among the top three states exited by millennials, and more Americans are moving out than moving into the Empire State. New York faces a $2 billion tax shortfall and will, no doubt, speed the exodus with higher taxes on those remaining. Under Mayor Bill de Blasio, New York City’s spending has risen 20 percent this fiscal year to $61.3 billion. Pension obligations are up $1.2 billion from four years ago to $9.5 billion annually, the Wall Street Journal reported, with more to come due to new municipal union contracts.

This strategy of tax increases that encourage taxpayers to leave is the government equivalent of a private-sector firm raising prices when its products are already overpriced. New Jersey incurred a major tax hole when a high-profile hedge fund manager decamped several years ago, and yet Governor Phil Murphy wants to raise taxes on millionaires.

In government, there is no bottom line watched by shareholders, so there is no incentive to run efficient organizations — as long as voters don’t revolt and the disgruntled taxpayers simply leave for lower-tax venues. Former Indianapolis mayor Stephen Goldsmith said famously that politicians can go to jail for stealing money, but not for wasting it.

To be sure, state government leaders claim they strive for efficiency, but if they did, wealthy states with high incomes per capita would have low tax rates. Those tax rates applied to large incomes, property values and retail sales would generate ample revenue to cover the costs of efficient operations.

Nevertheless, reality is quite the opposite. Connecticut, with the highest income per capita last year, had a state income tax burden of 10.6 percent, according to the Tax Foundation and Bureau of Economic Analysis. New York, third in income per capita, had the highest state income tax rate, 13.5 percent. New Jersey was fourth in per capita income and had a 9.2 percent income tax rate but a 2.4 percent property tax rate, the nation’s highest, edging out Connecticut’s 2.1 percent rate.

In contrast, Alabama ranked 46th in income per capita and had an income tax rate of 7.4 percent and 0.4 percent for property taxes. Kentucky was 47th in income per capita but taxed its citizens’ incomes at a 4.1 percent rate and 0.9 percent on property.

Even if those very blue states where tax and spending is endemic suddenly turned red, taxes will continue to rise because of the tremendous albatross of pension fund obligations. New Jersey has a pension funding gap that equals 42 percent of state gross domestic product and Connecticut’s is 31 percent, according to the Pew Charitable Trust. Many officials, back in the 1990s when the S&P 500 Index rose 20 percent for more for five consecutive years, assumed that rally would persist indefinitely and easily fund the generous pension fund benefits they were exacting.

By 2001, major police and firefighter pension plans nationwide had a median 101 percent of pension fund obligations set aside. Now, those first-responder pensions have median funding of just 71 percent and municipal pension funds in total have a median 78 cents for every dollar needed to cover future liabilities, Pew Charitable Trust figures show.

Furthermore, many state and local officials pushed costs into the future by promising pension benefits in lieu of present wage increases for public employees.

Now the chickens have come home to roost, and new Governmental Accounting Standards Board principles this year urge state and local officials to record all health care liabilities on their balance sheets. The nationwide $696 billion shortfall in retiree health benefits as of 2016, up from $589 billion in 2013, adds to the promised $1.1 trillion in pension benefits. States have just $47 billion in assets to cover $696 billion in health care liabilities.

New Jersey has unfunded pension liabilities of $90 billion, and a bipartisan commission recently recommended scaling back the health coverage and shifting many public employees to a hybrid pension plan in order to keep benefit costs at 15 percent of the annual budget. But that’s very unlikely given the current makeup of the state’s governing bodies. At the current trend, those costs will reach $10.7 billion in 2023, more than a quarter of the state budget.

So, if high state and local taxes are giving you the urge to move, pack your bags and call the movers sooner rather than later.