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.

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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

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4 Comments
  1. Panayotis Economopoulos says

    Look at the last posts oof my wall for a dynamic analysis!

  2. DavidLazarusUK says

     I can see major problems ahead. If high  unemployment is tolerated for too long expect to see serious long term problems. What will be needed will be work programs and training. This is unlikely because most governments are now more concerned with austerity. This will mean a lost generation and serious problems for future governments. So Mohamed El-Erian is right that nothing will be done to address structural problems, and I suspect for many years. I can see major problems ahead. If high  unemployment is tolerated for too long expect to see serious long term problems. What will be needed will be work programs and training. This is unlikely because most governments are now more concerned with austerity. This will mean a lost generation and serious problems for future governments. So Mohamed El-Erian is right that nothing will be done to address structural problems, and I suspect for many years. 

  3. Anonymous says

    I can see major problems ahead. If high unemployment is tolerated for too long expect to see serious long term problems. What will be needed will be work programs and training. This is unlikely because most governments are now more concerned with austerity. This will mean a lost generation and serious problems for future governments. So Mohamed El-Erian is right that nothing will be done to address structural problems, and I suspect for many years.

  4. jimh009 says

    Edward,

    Could you elaborate this comment from the article into plain English?

    “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.”

    1. Edward Harrison says

      He is saying that Pimco intends to take a long term approach by getting into
      quality credits now before the bad policies of the profligate spenders come
      to bear. They expect negative real rates to eventually lead to currency
      depreciation and inflation, compounding the direct losses from financial
      repression. So they want to get out while they can.

      They are mainly talking about the US and the UK.

  5. Anonymous says

    Edward,

    Could you elaborate this comment from the article into plain English?

    “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.”

    1. Edward Harrison says

      He is saying that Pimco intends to take a long term approach by getting into
      quality credits now before the bad policies of the profligate spenders come
      to bear. They expect negative real rates to eventually lead to currency
      depreciation and inflation, compounding the direct losses from financial
      repression. So they want to get out while they can.

      They are mainly talking about the US and the UK.

Comments are closed.

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