Gary Shilling: Why I love bonds

Jody Clarke talks to economist, Forbes columnist and amateur beekeeper, Gary Shilling.

One UK hedge fund manager is saying that stocks are at the start of a five to ten-year bull run. What do you think?

Gosh, I hope I live that long. Theory follows fact. And the fact is that we've had a strong rally. So everybody comes up with a theory not just to substantiate its existence, but its continuation as well. But to substantiate the height of stock prices now, you have to believe that consumers will stop saving and start spending again like drunken sailors.

And I just don't believe that will happen. We're not going back to the good old days, when US consumers reduced their savings and increased their borrowings, and their share of GDP and fuelled growth in the rest of the world via our imports.

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For the first time in 25 years consumers have moved from a borrowing and spending binge to a saving spree. We're looking at a one percentage point a year average increase in savings rates for the next decade.

That reverses what had been a half-percentage point average decline for the last quarter century. And for every 1% rise in consumer spending, American imports jump 2.8%. That's the post-World War II average. So I think we've crossed a watershed. The tectonic plates have shifted.

So even if GDP jumps, you don't think we're over the worst?

In the US, we've had 11 recessions since World War II. In eight of them there's been at least one quarter of increase in real GDP in the midst of the recession. In other words, the norm is a stop-go recession. It's not a 'start at the top and go to the bottom in one swoop' kind of scenario. I think this is no different.

Can Asia save the world?

In November 2007 we [A. Gary Shilling & Co] did a report on whether China had a big enough middle class with enough discretionary spending power to sustain the economy if US consumers tanked. The answer was no.

You need $5,000 [a year] to have discretionary spending power in China. There are about 110 million people with that, but that's only about 8% of the population. In India it's 5%. In the US it takes about $26,000, but that's 80% of Americans. As emerging markets industrialise there will be more middle class people. But that's a decade-long project. It's not going to happen in the next year or two.

So does buy-and-hold investing still work as a strategy?

As I said, theory follows fact. The fact is that from 1982 to 2000 you had a very strong bull market in stocks. So the theory was buy and hold. But the reality is that buy and hold only works if you have a straight-up market. We obviously don't have that anymore. In the last nine years, we've had two declines of 40% and there have only been four since 1900. So buy and hold is not a viable strategy. Neither are attempts at diversification.

What's wrong with diversification?

Diversification is wonderful if you have zero, if not negative, correlation among asset classes. But last year, guess what? Except for Treasury bonds, gold and in the currencies the dollar versus the yen, everything went down. We have a list of 38 investment categories, including junk bonds, commodities, hedge funds and stocks throughout the world; only three of the 38 went up. People think they're diversified, but they're not.

You've always been quite bullish on government bonds. Why is that?

Most people think Treasuries are for little old ladies and orphans. But I've been a fan since 1981. If you bought a 25-year zero coupon bond in October 1981 (which saw the bottom on prices and the top on yields) and rolled it over every year to maturity, you were 11 times better off than if you bought the S&P 500 at its low in 1982. And that was one of the strongest stock rallies on record.

Some people say bonds are complicated. Nonsense. You have no credit risk with Treasuries, so all you're really worried about are interest rates. What do you have to understand to own stocks? You have to know about the economy, what's happening in the sector, whether the CEO is a crook, are they going to be run out of business by a competitor, etc. There are so many things you need to know about stocks and so few about Treasuries.

Do you like any equities?

I'm a strong believer in North American energy not renewables, I'm much more in favour of shale gas, Canadian oil sands, nuclear and coal gasification, because I think that we as a country have decided we want less dependence on the Putins of this world. But the reality is that North America long ago exploited its cheap energy, so it's going to be more expensive.

The pundit who predicted the housing crash

A former chief economist at Merrill Lynch and a Forbes columnist since 1982, Gary Shilling was among the few pundits to foresee the housing crash and its impact on the global economy. He also foretold the bursting of the tech bubble in the late 1990s.

The son of a dentist, his route toWall Street was rather unorthodox. After majoring in physics at Amherst College, Massachusetts, he spent summers working in road construction before taking a year out to work as a junior officer on a friend's father's oil tanker. "My job was to play bridge with the captain and write letters for the crew in English." His hobbies include bee-keeping; he has 80 hives in New Jersey.