March 15, 2010
Mohamed El Erian's market note this morning with my translation.
Investors Must Keep Cash, 'Retain Optionality': El-Erian
Reuters | March 15, 2010 | 10:03 AM EDT
Investors should be holding healthy levels of cash in order to take advantage of "known unknowns" that become clearer as the economy evolves, Pimco's Mohamed El-Erian told CNBC.
The list of "known unknowns" is long multifaceted and at any time could turn in an unanticipated direction.
"The mindset is critical," he said, for investors who need to understand that the environment has changed in terms of government policy adjustments and cyclical events that influence markets.
QE has changed the investment landscape globally.
Those cyclical moves are important to note for how they perform within the larger structural environment of financial markets, said El-Erian, co-CEO of the world's largest bond fund.
"There are cyclical tailwinds for now that are going to overcome the structural headwinds," he said.
At some point in the future the structural headwinds of: dramatically reduced bank lending, 25% of mortgage holders underwater, reduced consumer spending, unsustainable entitlements, debt as a result of government stimulus, etc will have to be faced
"You construct a portfolio and more importantly you retain optionality," which said should entail "cash for very high-quality holdings that allow you to reposition as the future gets clearer."
Investors must be very defensively positioned holding high percentages of cash and cash like instruments because of the long list of horribles investors face down the road.
The ability to react to events could be critical for investors who are used to things happening in a more predictable fashion.
At any time from any direction an event/events could reset investor’s perspectives on markets overnight
"This is a wonderful time to be an active manager, with all these things moving," El-Erian said. "We are in the midst of a paradigm shift where things happen but they don't happen in the linear fashion that everyone wants them to happen."
In contrast, he said the Federal Reserve is likely to stay in a holding pattern when it meets this week to put together its own strategy to manage monetary policy.
"They're not going to do anything dramatic because they want to see how the tug of war between the cyclical tailwinds and structural headwinds plays out," he said.
El-Erian said he expects to see "a multi-speed world" where "part of the world is going to grow and grow robustly. There's going to be another part, the US and UK, that is going to have difficulty once all the stimulus and inventory cycle goes through."
The following are some selected points David Rosenberg made this morning.
· Here we have the greatest stimulus experience in seven decades and retail sales are still down 5% from the pre-recession peak and on a per capital basis are down 8%. Sales are actually lower today than they were in January 2006 — four years ago — even though the population has risen 4.3% over this time. And on a per capita basis, retail sales are no higher today than they were back in July 2005. Then adjust for inflation and draw the picture of real retail sales on a per capita basis (see below) and you shall see that they are down to 1996 levels. Don’t bet against the U.S. consumer? Sure thing.
· Then again, we are talking about a market for public equities that is hardly always rationale — for example, investors bidding up transport stocks this year by 8% and outperforming the oil stocks by roughly 800 basis points despite the fact that crude prices have jumped above $81/bbl (for the transports, this is a higher cost; for the oils, this is a higher revenue stream). The S&P retailing index is up 8% year-to-date too even though the University of Michigan consumer sentiment index has rolled back to where it was last December and the weakening ‘expectations’ component pointing to a very sluggish spending pattern over the next 4-6 months. But for a momentum-driven market, fundamentals can often be dismissed, for a time. But for astute and patient investors, this is what opportunities are built on — anomalies.
· Fiscal concerns in the U.K. are back on the front burner, which is why the Sterling is behaving even more poorly than the Euro. The debt service-to-revenue ratio there, along with the U.S.A., is the highest of all major AAA-rated sovereigns (Moody’s actually said today that both the U.K. and the U.S. have moved “substantially closer” toward losing their AAA status). CDS spreads are back widening again.
· Elsewhere we see that some EU finance ministers have come out and ruled out any direct aid for Greece and we all know that the entire risk trade of the past year was built on a sense that governments would be there to hold Mr. Market’s hand and bail out whoever needed to be bailed out. As a result, the Euro has snapped a three-day winning streak and the DXY index has retained a positive tone, which runs inversely to the pro-cyclical market trade in general.