El-Erian on Investing in Periods of Financial Repression
Yesterday, Pimco Boss Mohamed El-Erian released a note entitled "Navigating the Multi-Speed World". The summary was as follows:
- We see a hobble through scenario for the foreseeable future. It is a world that heals slowly and unevenly, and remains structurally impaired.
- Balance sheets, both across and within economies, are still out of equilibrium. We expect advanced economies will face sluggish growth and persistently high unemployment over the secular horizon. Emerging economies will achieve higher growth but face recurrent inflationary concerns.
- We do not expect policymakers to boldly address structural problems. By targeting negative real interest rates, they will pursue financial repression that undermines the “real return” contract that savers expect.
- Secular baseline portfolio positioning should minimize exposure to the negative impact of financial repression, hedge against higher inflation and currency depreciation and exploit the heightened differentiation in balance sheets and growth potentials.
Financial repression and fiscal profligacy have been the themes of Pimco’s monthly investing newsletters for a number of months. Here is a sampling of my analysis of Bill Gross’ comments.
- Bill Gross: ‘Low policy rates represent an immediate threat to investment portfolios 3 May 2011
- Bill Gross on fiscal profligacy and dumping the negative real yields of treasuries 31 Mar 2011
- Gross: Central Banks are Robbing Bond Holders and Fuelling Inflation 5 Feb 2011
- Bill Gross: Devil’s Bargain 2 Feb 2011
- Bill Gross: Deficit Hawk, Bond Vigilante 5 Jan 2011
Now, remember as late as December of last year Bill Gross was saying "The global economy is suffering from a lack of aggregate demand." So, Pimco has changed its tune considerably.
If one understands how quantitative easing really works and the intention of Federal Reserve officials from prior statements, it is clear the Fed is not trying to re-equilibrate risk premia in the face of a dysfunctional private sector credit mechanism. Rather, the Fed is artificially manipulating interest rates lower, suppressing real yield for fixed income assets, in a bid to add stimulus to a sluggish economy. This has caused Pimco to look to countries like Canada for safer developed economy sovereign bonds, to emerging markets for yield pickup with better macro conditions, and to equities and gold for greater risk as the bond bull market fades.
When I said a bit more on the currency wars and negative real rates late last month, I indicated that financial repression leads to investors’ leveraging up, moving abroad, moving out on the risk curve or moving into riskier asset classes. Apparently, Pimco is employing all of these strategies. Will it work, though? I think Gross’ own term, Devil’s Bargain, is on the money here. He said he believes that 4-5% real returns are possible from conservatively positioned bond portfolios. I say greater risk doesn’t always mean greater reward; risk can also result in losses. Treasuries have rallied of late and other investors like Jeremy Grantham and Felix Zulauf are reducing risk right now. In my view, the greater risk is to the downside at this point in the cycle. That means leverage and risk-seeking strategies will result in underperformance and could lead to losses.
Full article embedded below.
Source: Navigating the Multi-Speed World, Mohamed El-Erian, Pimco