A Case for the Bear, Equities

Interviewed by George Brooks of Equities magazine for their September 2009 issue: "A Case for the Bear ... Contrarian Jim Shepherd doesn't buy the bull".

At a time when 90% of private economists surveyed expect the worst recession since the "Great One" to end in the third quarter of this year, Jim Shepherd of The Shepherd Investment Strategist is screaming "No way!"

Shepherd is not one of those incorrigible bears, always raining on parades, having made bundles of money for clients on the long side over the years issuing "buys" in 1982 with theDow Jones Industrial Average under 800 and again in 1998 when the implosion of a hedge fund called Long-Term Capital Management scared the wits out of Wall Street, forcing a government- sponsored $3.6 billion bailout.

He proved equally adept at calling for a bear in 1987 when he called for a crash, before a 40-day, 41% free fall in the Dow, and most notably again in 2007* when he recommended inverse exchange traded funds, making more than 20% for clients at a time when investors were getting crushed.

Shepherd is using the 47% surge that occurred duringMarch to July in the Dow to urge clients once again to sell, in expectation of a savage plunge possibly as low as 3,000 to 4,000.

Shepherd relies on the model he developed decades ago that encompasses time-tested economic, financial, monetary, and technical inputs. That model is now calling for a period of deflation to be followed by a period of wrenching inflation. In August, he was on high alert for a "deflationary spiral signal" derived in part from the behavior of producer prices. So what is behind this contrarian's bold stand?

Several things, actually—with the American consumer at center stage. "The real key to an economic recovery is the consumer, and we haven't seen evidence of that," Shepherd says. "And I don't think that what has been done [by the government] has been effective or will be effective."

Shepherd doesn't think the trillions of dollars the U.S. government has spent, and promises to spend, will get the job done. "If you look at bank reserves, you will see the banks have taken the money they received and hoarded it, and excess reserves over required reserves have shot up dramatically, indicating that banks are not lending," he says. Most surveys of lending institutions show that conditions have become more restricted for consumer lending, and there's still a massive amount of problem loans in commercial real estate, mortgages, and credit cards.

Add to that the enormous devaluation in each American's net worth—in terms of the stock market, home prices, and employment—and you have the seeds for deflation.

All combined, Shepherd sees deflation growing near term and the U.S. dollar rallying strongly, since at the moment, it is still the world's reserve currency. Because commodity prices are denominated in dollars, he sees them tumbling as the dollar rises. Concurrently, he believes there will be a flight to safety to U.S. Treasuries.

INVESTING IN BRIC?

Again, a "No Way" from Shepherd, who reasons that the demise of the U.S. consumer is the mainstay of those economies, and its retrenchment will be felt big time. While he concedes that those countries offer a great deal of potential, their economic strength between 2003 and 2007 was driven by the U.S. consumer's debt-based spending.

"There is no way those countries can replace the U.S. consumer, and we see a big shrinkage in our trade deficit as a result," Shepherd says. "The only edge they have is that they have reserves; we don't. We have to sell our debt in order to continue to operate."

IS IT 1929 ALL OVER AGAIN?

There are distinct similarities, Shepherd says, noting the massive fallout in economic activity and dramatic declines in the velocity of money. Between 1929 and 1930, we saw what most people think of as the great stock market decline during which the Dow peaked in September 1929 at about 380 and fell dramatically into 1930. Shepherd says that the Dow then rebounded 50%until spring of 1930. Most people thought the worst was over, but the stock market resumed its free fall, plunging close to 90% before bottoming out near 40 in 1932.

The consumer is in worse shape now than in the 1930s, even though there are more protections in the banking system now, he says. Consumers were not in debt in the 1930s, and the country was not in debt like it is now. "In my opinion, we have run out of bullets to fire at this problem, and as realization of that, this so-called recovery is not real," he says. "It is just a temporary recovery, and as unemployment continues to worsen, all those things will converge."

* Error in original article. Call was made in 2008.