The global investment environment continues to be dominated by deleveraging, according to famous economist Gary Shilling.
The financial sector and household sector need 9.5 years and 8.3 years, respectively, to return their balance sheets to trend. And until this era is done he expects average real GDP growth to be about 2 percent.
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.
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 favor 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 percent.
Source: A Gary Shilling
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