Notes from the Pimco Lunch with Rob Arnott
- Joshua M Brown
- September 21st, 2011
Today I had the pleasure of attending a luncheon at the Ritz-Carlton in NYC to hear one of the great intellects of the investment management business speak - Rob Arnott, founder of Research Affiliates and manager of Pimco's All Asset Fund.
Over his 30-year career, Robert Arnott has endeavored to bridge the worlds of academic theorists and financial markets. His success in doing so has resulted in a reputation as one of the world’s most provocative and respected financial analysts. Rob has pioneered several unconventional portfolio strategies that are now widely applied, including tactical asset allocation, global tactical asset allocation, tax-advantaged equity management, and the Fundamental Index® approach to indexation.
Rob spent some time giving us his views on the current economic picture, the big headwinds we face now and how we should be allocating for what's to come.
I'm jotting these nuggets down here off the dome, normally I take notes before putting out one of these posts but the food was actually decent so my hands were full...
(Mostly paraphrased except where in quotes)
On the Double Dip Recession: It's already begun, especially when you look at structural GDP (GDP minus deficit spending by the government). It looks like government spending will decline which virtually assures recession.
On Bipolar Markets: "When bonds and stocks disagree, the bond market is usually right."
On Greece and the PIIGS: By some measures of spending money we don't have, we are even bigger pigs here so we shouldn't be calling names. Greece would be wise to "cross the river" sooner than later because the river is getting faster and will only be tougher to cross with every passing day. (editor's note - I think he means default)
On Inflation: It will continue to tick up through the end of the year (in the form of CPI), the rolling three year average inflation rate will start to look scary (5% annual rate) as we start to lose the deflationary 2nd half of 2008 in that rolling three year number. Now imagine 2% Treasury yields and 5% inflation rate and how equities will respond to that.
On the Paradox of Inflation and Recession Co-Existing: So you say that with 10% unemployment and collapsing housing prices that inflation can't truly exist? Go ask the folks in Zimbabwe about their job and housing markets during the country's epic bout with inflation.
On Inflation and Stocks: It turns out that anything above a 4% inflation rate is very harsh for stock market PE ratios, they are very sensitive at that level and compress.
On Inflation Tools: TIPS are very expensive but could go even higher, junk bonds are actually a great inflation hedge - it turns out they outperform TIPS in that regard, REITs could get interesting for inflation hedging but not at today's prices. Commodities are the best bang for your buck in an inflationary environment, they are a 10x reaction, meaning if inflation jumps 2%, commodities as an asset class give you a 20% response.
On US Debt Problem: There are 3 ways to get through our current situation -
a. Austerity (too painful politically and economically, look at Greece - millions of private sector jobs lost, not a single government layoff)
b. Abrogation (as in not paying our debts. Russia and China will be thrilled, lol. There are some debts we have that aren't actually debts - merely obligations - like entitlements and such. These will come down but not enough.)
c. Run the Printing Presses (which is what Bernanke has been doing, it is politically very tempting to print more - make the debt worth less dollars - much easier to do this than austerity so it will continue)
On Demographics: Pimco's been doing a lot of work on demographics, some of their research will be out in a few months. It turns out that there are crazy high correlations between demographics and stocks but you have to use longer time frames because demographics are sloooooooow. Five year rolling average stock market and bond market returns more meaningful than annual numbers in this context. The gist is that people add the most to their nation's GDP growth in their 20's and 30's...they make the biggest impact on that nation's stock market returns at around 40 just as their contribution to GDP growth is starting to level off. This is important when looking at market opportunities around the world and at home.
On Emerging Markets: Demographically speaking emerging markets are getting into the median age sweet spot for GDP growth and then stock market performance - example was in India the median age is not yet 30 years old. China will hit that Great Wall of Demography everyone is worried about (because of the one child rule) but not for 15 to 30 years.
On What to Avoid: Growth stocks and long-dated Treasurys are an avoid. Multiples on growth stocks will not react favorably to a recession and inflation and long bonds are getting dangerous here. The one caveat is that "if Greece or Japan cross the Rubicon" in the next three months, Treasurys will certainly shoot up to even greater heights.
On Apple: Apple investors have given the company the highest market cap in the world - a de facto statement that "Apple is in a position to return more in profits to shareholders than any other company". In reality, Apple just isn't that big, it's not even in the top 40 companies by profits. Investors are betting, at these prices and multiples, that Apple is infallible. Favorite equity pairs trade (half joking I think) might be Long Bank of America, Short Apple - in one case expectations and sentiment pricing in the absolute worst case scenario, the opposite in the other.
On What to Do in Case of Recession: He is staying extremely liquid and underweight equities (only 8 to 12% of portfolios as per public filings), when the market adjusts to the high, scary inflation data and acknowledges the new recession, he expects asset prices to get "appreciably cheaper", but instead of buying the dip in US equities, he is more inclined to take advantage of the Emerging Markets stocks which will likely fall in tandem with developed markets.
On Gold and Swiss Franc as Safe Haven: He wouldn't buy either one looking for big gains and "you'd better hope you don't have big gains in those because you can just imagine what the rest of your portfolio would look like if you did..."
I'm not currently invested in the funds Rob manages but it was great to hear his thought process and outlook. if you guys like posts like these I'll put them up more often so let me know below.
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.