Gary Shilling had previously said that there was a "Grand Disconnect between robust security markets and subdued at best economic reality."
This along with low interest rates had distorted markets and caused investors to chase yield without truly appreciating financial risk.
But he always maintained that the 'Grand Disconnect' was unsustainable and a 'shock' could close this gap.
In the latest A. Gary Shilling's Insights he writes that recent Fed comments on the taper — reducing the the $85 billion monthly bond buying program intended to keep long term interest rates low — could just be that shock. What's more? Investors are facing other shocks too, like a financial crisis in China as its policymakers crack down on shadow banking.
"A sufficient shock will shift investment strategy from 'risk-on' to 'risk-off'," he writes. In light of this Shilling has shifted to "risk off" investment themes.
In this scenario, Treasury bonds and Japanese stocks are attractive. Also, the dollar vs. the yen, euro, and commodity currencies are a good bet.
Meanwhile, developed country stocks, homebuilders, junk bonds, commodities, and emerging market stocks and bonds are unattractive.
"Also caught in the shift from 'risk-on' to 'risk-off' are closed-end bond funds where leverage and investor zeal magnified their performance earlier but recently have promoted grief. The average closed-end bond fund has fallen 10.7% in the past month compared to a 3.4% decline in open-end bond funds. Some 61% of the $276 billion in closed-end funds is in bond funds. The shift in investor attitudes pushed municipal closed-end funds from selling at a 2.1% premium to book value in January to a 6.2% discount recently while the 2% premium on junk closed-end bonds turned into a 5.9% discount...
"Already, three members of the "risk-off" quartet are in place as stocks and commodities fall while the dollar strengthens. The fourth member, Treasurys, were hit by the Fed's announcements but may rally as falling stocks highlight their safe- haven appeal and overshadow fears of QE terminus."
Shilling adds that his investment themes are always in transition.
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