Sunday, August 5, 2012

Confusing Pronouncements From PIMCO

Bill Gross has made provocative pronouncements about the "Death of Equities."  I have the highest respect for the wit, clarity and investment insight that Bill Gross has brought to his investment commentary over several decades.  His early comments about the unsustainable nature of G.E.'s corporate earnings growth from GE Capital, for example, were way ahead of Wall Street analysts and strategists.  This latest commentary seemed a bit huffy, and lacked his usual clarity.

Equities can't sustain their historical real return of 6.6% per annum, given prospective low growth rates for global real GDP.  Equities are very volatile, and a decade of returns can be given back in a year or two. Both of these statements seem eminently reasonable. But, the death of equities as an investment class?  I get lost here. 

Bonds certainly won't be able to maintain their recent historical performance, even given a benign inflation outlook.  Too much money has piled in, chasing returns.Valuations on high quality corporates and even junk bonds, are stretched. 

Now, Robert Arnott, who is involved with PIMCO's asset allocation and equity-related products has made a pronouncement about the tripling of inflation rates. 

"Round 1 of the inflation debate has seemingly been won by the doves. But Robert Arnott believes the hawks will be proved right, and soon. The inflation rate has "an 80% chance of topping 5% within five years," says Mr. Arnott, founder of Research Affiliates, a Pasadena, Calif. investment firm whose strategies are used to manage $100 billion worldwide."
His suggestions for investors?  Gold: too late, too risky and not well correlated with superior, risk-adjusted returns.  TIPS: not enough of them to satisfy the demand.  Junk bonds: I have a hard time with this quasi-equity asset class being the answer.  Emerging market debt and equity: investors won't get compensated adequately for the risks they are taking, and I don't just mean currency.  Real Estate: depends on what you mean.  Residential or commercial, and the vehicles.

PIMCO's push into alternative equity strategies and products has, I believe, produced tepid results and yawns in the market place. This has never been in the PIMCO wheel house historically. 

If inflation does rear its head, it would seem as if the equities of strong global companies with a degree of pricing power would be the place for investors to put their money.  That pricing power could come from technological leadership (like Apple) or from commodity-style pass throughs (Food or commodities).  Either way, it wouldn't seem like "death" were likely for these equities. 

Equities may have a longer term problem which will spill over on to global asset managers as a group.  However, I don't think that this has to do with mean reverting returns for the asset class, but, as the Pythons would say, "for something completely different." 

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