Gary Shilling Predicts Huge Drop In S&P Earnings, Lower House Prices and Treasury Yields (Deflation)

Gary Shilling, president of A. Gary Shilling & Co., was interviewed by Henry Blodget on Daily Ticker on 3/22 and said he expects deflation, lower house prices, lower Treasury bond yields (higher prices), and a huge negative surprise for S&P operating earnings going forward. And to top it off, he sees a new recession in 2012. Get ready...

On the 30 year Treasury bond bull market (not from an official transcript):

"I don't think it's over. I still think that we're probably more headed for deflation than inflation. That the world is going to see a lot slower economy, if not recessions, and Treasuries will be their usual safe haven. So I'm holding out for 2.5% on the 30-year, and probably 1.5% on the 10-year. The 2.5 is where they got at the end of 2008 after Lehman collapsed."

On stocks and a possible huge negative surprise for S&P earnings:

"I think they are being overly optimistic (on Goldman Sachs' call to buy stocks relative to bonds). The interesting thing is, employment has picked up, but employment has probably picked up because businesses are no longer able to cut costs as vigorously as they did. And that's been the route to profits - increased productivity, declining unit labor costs. That's no longer working. So they need to hire more people. But, the flip side is that I don't think profits will show that growth even if the economy holds up, and I don't think it will. So, the street is looking for about $105 for S&P operating earnings this year, and I think it will be closer to $80."

**Corporate profit margins are currently exhausted at record highs, so Shilling could be spot on about this.

House prices have not hit bottom yet:

"I still think we got a 20% decline in prices in store and it's because of the huge overhang of inventories."

"The big servicers, the five big services of mortgages, settled for $25 billion with the Federal government and the State Attorneys Generals. That's out of the way. They've been holding off on foreclosures because it was bad PR enough to have all these problems with the governments. Now I think they will go back to foreclosures. And the National Association of Realtors says that foreclosed houses are on average 22% below comparable houses..."

"The huge inventory overhang, and excess inventories are always the mortal enemy of prices, that, plus the dam breaking on foreclosures, I think we could have another leg down in home prices."

He also said banks deserve to be trading below book value.