By Jason Voss, CFA
At the recent CFA Institute Fixed-Income Management Conference in San Francisco, Blackrock Chief Investment Officer Rick Rieder contended that in the wake of the Great Recession the fixed-income market is undergoing structural changes that have not been present for at least 20 years. Among the major elements of this shift: the long-term continuation of artificially low interest rates and a shortening of investment time horizons.
Rieder also told attendees that investors are too preoccupied with issues such as a slowdown in China and fears that the US is condemned to the same fate as Japan's in the 1980s. These headlines have distracted from important, positive shifts that have taken place that provide good investment opportunities for those who know where to look.
Negative Structural Shifts
Rieder said that monetary policy actions undertaken by central banks in the US, Europe, and Switzerland to artificially lower interest rates are unprecedented examples of "money printing." He thinks that these actions have created financial repression in which those financial market participants who depend on higher fixed-income yields, such as insurance companies, pension funds, savers, and retirees, are not being paid an appropriate rate of interest on their capital. In some cases, this situation is causing business models and lives to utterly fail - hence the term financial repression. At the same time, global organic economic growth is slowing, Rieder contended, creating even further economic pain and putting pressure on central bankers to keep interest rates low for many years into the future.
Another important structural change Rieder highlighted is the shortening of investment time horizons. He pointed out that most money made in equities and fixed income occurs in very short bursts of return. For example, around 200% of the return of the Standard & Poor's 500 index surrounds market-moving comments made by central bankers, particularly the European Central Bank's Mario Draghi. Rieder believes that due to slower economic growth, coupled with both financial repression and high global indebtedness, future returns will likely continue to be generated in such short bursts.
Another negative structural shift on Rieder's radar is the unemployment rate in the United States. In contrast to the Federal Reserve, he believes that unemployment is not a cyclical problem. Rieder pointed to the number of skilled job openings that have remained unfilled due to a lack of qualified workers. To retrain the work force takes many years, he pointed out, so unemployment is likely to be a lingering problem for some time to come. Further pressure on labor markets comes from the permanent drop in the cost of doing business that has resulted from a combination of cheap information discovery via the Internet and an improvement in transportation logistics. This combination allows for businesses to grow themselves without hiring new employees.
Do Not Be Concerned With . . .
Topping the list of issues with which investors should not be concerned, according to Rieder, is whether the US economy will suffer the same fate that Japan did in the 1990s. He believes that Europe is actually much more like Japan. Rieder noted, for instance, that bank assets in the United States are just 100% of gross domestic product, whereas in Europe that same number is 300% of GDP. This limits the ability of Europe to create credit because it will take them so much longer to deleverage balance sheets.
Another issue Rieder thinks is overblown is the risk that results from an economic slowdown in China. Although he acknowledged that the slowdown is taking place, he does not believe that it will affect the global economy to the degree that many investors are worried about. Rieder also believes that inflation concerns in the United States are exaggerated: He pointed to the Federal Reserve's ability to instantaneously adjust "interest on excess reserves" as an immediate dampener on any future inflationary pressures and monetary velocity.
Positive Structural Shifts
Important positive shifts are also underway, Rieder told his audience. One such example is the fact that credit creation, which had been zero or negative since 2008, has recently turned positive. Additionally, he believes that economic growth in the United States is starting to stabilize and is likely to go higher. Another important dynamic: the velocity of money is beginning to improve.
Lastly, Rieder contended that the ECB has extinguished shocks from the system. This was accomplished, he said, by the bank's public promise to backstop any further fallout from the European sovereign debt crisis and its willingness to financially bail out Europe's peripheral nations.
Against this economic backdrop, Rieder offered his audience few investment ideas - but he did acknowledge his belief that high-dividend-paying stocks will continue to do very well.
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