In conjunction with a major recession in Europe, a hard landing in China and foreign-earnings translation losses caused by a rising dollar, the operating earnings of S&P 500 companies could drop to $80 per share this year, compared with Wall Street analysts’ expectations of $104. That would almost guarantee a major bear market with a likely price-earnings ratio low of about 10. This implies that the S&P 500 index (SPX) would be around 800, a 43 percent drop from its recent level.As usual, I haven't the slightest clue how good or bad this prediction is. It's right about in line with predictions of of other bearish market observers, including John Hussman and Jeremy Grantham. It might certainly come true. Or it might not.
For fun, I went back and found another Gary Shilling piece on Bloomberg from November, 2010. Since that piece contained a number of fairly quantifiable predictions, I thought it'd be interesting to see how correct they were in hindsight:
- Significant stock selloff within 12 months. At the time, November 12, 2010, S&P 500 traded at about 1200. It kept on rising to about 1350 before selling off into second half of 2011. But the lowest point of 2011 for S&P 500 was 1100 level in October 2011 and it didn't stay there for long. Plus it paid dividends in the process. So there was a fairly significant sell-off, but only after a fairly significant run-up. Starting with 1200 level at which Shilling made his call I would have to mark this one as WRONG.
- Real gross domestic product growth of 2 percent and maybe less in the next couple of years. The GDP growth has been a bit below 2% since, so this one is RIGHT.
- Shilling, who predicts that stocks will return 5 percent to 6 percent annually after inflation adjustments over the next decade, says that half of that will come from dividends and not from appreciation. Frankly, I'm not sure what to make of this call attributed to Gary Shilling in the article. 5-6% real return from stocks is quite an optimistic expectation and everything else Gary Shilling has said has been anything but optimistic. Nevertheless, this call has actually been RIGHT on the money, with S&P 500 returning just about 6% real on annualized basis from November 2010 through today. Though only about a quarter of total returns came from dividends.
- The S&P 500’s dividend yield, currently at 1.92 percent, may rise to at least 3 percent, Shilling said, without specifying a time frame. Dividend yield on S&P 500 is indeed slightly higher today than in November 2010 despite the 10+% increase in price, so Shilling got the direction right. But it is nowhere close to 3% (it's just barely over 2%) so I have to count this one as WRONG, at least for now.
- Yield on the U.S. 30-year bond will drop to 3 percent within the next “couple of years” from about 4.3 percent. This call for 3% yield on 30-year treasuries has been particularly impressive. RIGHT.
- “The dollar is probably going to strengthen,” Shilling said. “We’re going to see increasing problems in Europe, led by Ireland. As a result, we’re seeing a rally in the dollar.” The dollar did indeed rise against the Euro somewhat, and Europe certainly did see new turmoil in 2011 (and indeed, still seeing it today), but it wasn't due to Ireland. I will mark this one as MIXED.
So we see a hodge-podge of right and wrong calls here. If we take the prediction of 5-6% real return from stocks as being correctly attributed to Shilling then he was certainly more right than wrong. But such an optimistic outlook for stocks does clash with the general gloom of Shilling's messages, both now and then. More importantly, it clashes with his today's outlook on stocks which, from the quote of the top of the post, he sees as likely to drop full 40% from current levels!
I don't advise making any changes to your portfolio based Gary Shilling's (or anybody else's) predictions. As you can tell, his current market predictions are hardly consistent with his prior market predictions -- an inconvenient problem shared by just about very guru I know of.
But some truths of Gary Shilling's message are indisputable. The US and the world in general are still facing plenty of fundamental problems, mostly having to do with high debt levels. US stocks are not particularly cheap (they were cheap in early 2009 and have doubled since). The combination of these two facts make it difficult to realistically expect high returns from stocks, even if it hardly dooms them to necessarily lose 40% either.
With bonds being just as or even more unattractive than stocks, the most logical course of action is to hunker down for a period of uninspiring returns from all asset classes. That does not mean that a giant crash is necessarily around the corner. But it does mean that we are unlikely to see historically average returns from any asset class over the coming decade or two.
Instead of historical average 9-10% from stocks and 5-6% from bonds (nominal) we might do well to expect, say, 6-7% from stocks and 3-4% from bonds. Nothing to write home about, but still quite a bit better than 0% from cash which is your alternative if you take all this gloom and doom talk too seriously.