The people at PIMCO are at it once again, attempting to coin a phrase. In the wake of the financial crisis in 2008, Mohammed El-Erian & Co. gathered at their annual “Secular Forum” to discuss the state of the world in the context of asset allocation and broke huddle with a view that;
- the world would remain vulnerable to systemic shocks;
- growth in developed economies would be significantly lower for more than a typical cycle;
- governments would play a larger role in economies from both an economic and regulatory standpoint and;
- the “baton” of growth would be passed from developed economies to emerging economies.
The investment journey was seen as a turbulent one, with lots of slips and bumps, and the environment was characterized as “multi-speed”. The big encompassing tag for this view was “The New Normal”. At the time, this view was considered extreme and “idiotic” in El-Erian’s words at a conference for clients in NYC yesterday. Within a year or so, it was considered “fatalistic”. In time, it became conventional wisdom.
While the New Normal has very accurately described the world economy since 2008, it has missed the mark if one is measuring investment success only through the rear view mirror and only if one is chasing return with little regard for risk. To be sure, the most successful investors over the past 4 years have been those who have adopted more of a “normal” mean-reverting philosophy, embracing risk, buying on the dips and tossing caution to the wind. Does this mean the New Normal viewpoint was not a constructive part of the allocation framework? Only if you admire the success of the boy running through the dynamite factory with a lit candle and living to tell the story!
The big catchphrase at PIMCO today is “stable disequilibrium”. Originally coined by PIMCO in 2006 (which is interesting in itself) it speaks to stability on the surface with “weakening and increasingly unstable underpinnings”. As in 2006, but to a significantly larger degree, the aforementioned stability has been “purchased” and is not a result of natural economic forces. Specifically, the massive global expansionary monetary policy has pushed all investors out of the comfort of “safe” yield into riskier assets, thereby propelling the markets. True, stock market valuations are not ridiculous and there are many encouraging stories for investors to digest including developments in shale oil, 3D printing and big data applications. But PIMCO sees these encouraging points as “sector” stories, not macro events. Using a surfing analogy (attributed to the company’s headquarters in Newport Beach California!) El-Erian compared investors to surfers, some of whom wait fruitlessly for the perfect wave (investing opportunity) while others recognize the strength and power of the massive central bank wave and choose to go for a ride. This fairly represents the spectrum of risk-taking that investors have faced and most of us have been riding the wave of liquidity while trying to play some defense.
El-Erian presented an interesting analogy when he compared current central bank policies to pharmaceutical companies that continued to feed untested drugs to patients that really didn’t get any better! He pointed to monetary policy experiments currently taking place in the US, Europe and Japan and warned that markets would be unforgiving if the current complacency (fueled by liquidity) is replaced by disappointment that the policies didn’t work. Clearly the policies still stand a chance of working…we’re just sayin’.
Finally, El-Erian indicated that PIMCO was “walking and not running” away from risk. The central bank liquidity wave has been and will probably continue to be very hard to resist in a return-deficient world. The firm is being “selectively” offensive (emerging markets, non-Agency mortgages, distressed debt) and is actively working to hedge against “haircuts” (encompassing everything from defaults to unanticipated inflation and currency debasement) caused by weak balance sheets, anemic income statements and bad management.
The keys to success in this environment, in El-Erian’s estimation, are resiliency and agility. Be prepared for some bumps and bruises and stand ready to shift when the opportunity presents itself. This is very different than “buy and hold”. As it should be, in the New Normal.