Stocks are pushing into record territory, but there’s reason to be defensive, according to Gary Shilling, President of Gary Shilling & Company.
“I’ve said we are in a “risk-on” environment and I think we ought to be cautious because what’s the basis of this economic expansion has really been the Fed money and P/E plays,” he says. “As far as profits, it’s been cutting costs, profit margins. It hasn’t been basic increase in sales volume and pricing power and I think that situation is still intact.”
He believes the defensive posture he’s maintained even through the recent run-up in stocks is “the better part of valor” for the time being. As far as when that defensive posture could start to soften, Shilling believes investors need to be prepared for a “shock” that could send a shiver through the markets.
“How long is this risk on environment going to last,” he asks. “I think it’s either until we get some shock out there that really bothers people – something like a blowup in the Middle East or a big problem in China or unexpected weakness in this country.”
Short of a shock, the other catalyst that could encourage a more offensive investing posture in his view is when the Fed begins to tighten interest rates. And Shilling takes a long term view on when that may happen. He believes it could be a couple of years before the Fed shifts to a more hawkish policy.
So if Shilling is right, where should investors look for smart defensive plays in this market? He offers three sectors where he’s putting money to work, and two investments he’s shorting. “In the equity area, we’re looking at defensive plays, things that have dividend yields, things that people buy regardless: utilities, consumer staples, health care.”
But he’s also had some success with short interest plays in currencies and commodities. “We’re also short the euro currency because the European Central Bank is basically out to trash the euro,” says Shilling. “They see that as fostering deflation because it reduces the cost of imports and forces those who compete with importers to reduce their costs, so that’s been another play as far as we’re concerned.”
While many investors rush to the safety of commodities when looking for defensive alternatives to equities, Shilling’s not a buyer. “[Commodities have] been a loser,” he says. “Commodities have been declining since the beginning of 2011. We’re actually short copper in our portfolios… because it goes into almost anything that’s manufactured globally and we do have slower global economies and plenty of supply.
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