Gary Shilling: Recession Probably Shaping Up

There's been a big run in earnings. A lot of that was because of the tax cuts. But the strong dollar creates losses for U.S. multinationals with foreign earnings when those translate back into dollars. That's a factor — though earnings tend to be more of a coincidental indicator; they pretty much ride with the economy.

What do the recent earnings indicate?

A slowing economy — slowing momentum — is what you get toward economic peaks. Earnings that were growing start to slow before they actually decline. Also, record job openings and low unemployment are very reminiscent of a peak in the economy.

What will be the impact of President Trump's trade war with China?

[Trade wars] tend to slow things down in the economy too because of the uncertainty and reorientation of supply relationships. I think the U.S. is going to win against China because we're the buyer, and they're the seller. With plenty of goods and services in the world, it's the buyer who's got the upper hand — and Americans buy all those consumer goods. But the transition is the biggest [concern] on a short-term basis.

Please elaborate about that transition.

It's difficult because you've got to shift things around, and conventional business relationships get shaken up. That tends to slow down economic activity and promote deflation. The transition is an inefficiency and a deflationary force.

What's your forecast for oil prices, which have been rising?

There's plenty of supply and peaking demand. So I think that long-term, the outlook for oil prices is probably not so hot. There's going to be peak demand. That's ironic because earlier we probably had a peak in supply. We've gone from concern about peak supply in oil to a peak demand — an amazing change.

What are contributing factors to the peak demand?

Conservation measures and alternatives, like wind and solar power. Natural gas has become a big competitor. If electric vehicles really take off, it's going to make a huge dent in the demand for gasoline and, hence, oil. Half the oil in this country goes into transportation, and half of that is in personal transportation.

Why are you bullish on bonds at a time when many other experts are bearish on them?

Right now, you've got a tradeoff between spillover in bonds from the Fed raising rates on one side and deflationary forces on the other. But the spillover from the Fed's actions is relatively muted. The portfolios we manage have moderate bond positions, which are doing very well to date because bonds are a safe haven. When stocks are falling out of bed, people look at safe havens, and those tend to be bonds and the dollar. In the long run, what affects bonds is inflation.

So the U.S. isn't in an inflationary environment?

We're in a very deflationary world. Protectionism is extremely deflationary. It disrupts economies and slows down growth. But we're still in a very much globalized world with cheap production on a global basis. So unless we go completely protectionist, we're going to continue to see downward pressure on prices.

Are there many other deflationary forces in the world right now?

Yes, a lot, especially in services. And services are where it really matters: About two-thirds of consumer spending is on services, only one-third on goods. Look at financial services. It's a competitive race to the bottom!

You've been a sharp critic of the Federal Reserve, which, in a July 2017 interview with me, you called "completely clueless." How do you assess the Fed now that it's hiking rates?

The Fed is doing what they think they have to do. They don't want to kill the economy, but they worry about overheating. They also want to have rates high enough so they can cut them when the next recession rolls around.

What do you think of Chair Jerome Powell's job performance thus far?

The Fed isn't yet back to a neutral rate; and he's, sort of, saying, "We don't know where that is." Basically, he's saying that [the Fed] is forgetting about "forward guidance." I think that's one of the most encouraging developments.

What's "forward guidance," and why is dispensing with it a positive?

In the aftermath of the financial crisis, the idea of transparency [became a focus]. And the Fed — these guys are mere mortals — got bitten by the transparency bug as well. So they came up with "forward guidance" — the idea of telling the world what they were going to do in the hope that it would create stability.

What was the result of that policy?

It was a huge mistake because the Fed has been a very poor forecaster. Their data-driven decisions have been pretty lousy in forecasting the economy. They've been way overestimating growth, raising interest rates and inflation. From our standpoint, forward guidance hasn't created stability. So forgetting about it is a big improvement.

Let's now turn to your hobby for nearly 30 years: beekeeping. It's "an ever-changing mystery to be solved … by analytic thinking" and a bit of luck, you write. How are you preparing your 100 hives for the cold weather?

We're tucking them in for the winter. Bees make honey to get through the winter, but sometimes they run out; so we put in sugar syrup for them to make sure they get enough to eat. We put mouse guards on the entrances of the hives because mice love to get into beehives when it's cold. It's nice and warm in there. They eat the honey and raise hell.

— Related on ThinkAdvisor:

• Recession Is Coming in 2 Years or Less: Adam Tooze
• A 'Vicious,' Fed-Fueled Economic Crisis Is Coming, Ex-Goldman Banker Warns
• Bonds Will Withstand US Borrowing Binge