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Ian Campbell

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Financial Markets: What Should Investors Do?

Mohamed El-Erian is CEO of Pimco, a U.S. based global investment management company with +$2 billion in assets under administration. Speaking at a Conference organized by Altegis Investments and John Mauldin, Mr. El-Erian addressed what investors ought to be considering in the prevailing uncertain economic times. In summary, and paraphrased, asMr. El-Erian currently sees things:

  • today the majority of 'investor recommendations' are based on a view that 'stocks are cheaper than something else', not on 'fundamentals' - and that is "potentially very dangerous";
  • Central Banks are forced to 'stay on their current trajectory' (by that I assume he means 'continued quantitative easing') and continue to 'work at' boosting confidence;
  • eventually all 'waves break', and the question is does a surfer (read 'investor') 'walk off the board' or 'crash'. Like any surfer, how each investor is 'positioned' will determine the extent of whether he/she 'suffers or not';
  • there is more than 'one wave' out there beyond the wave created by the Central Banks that the Central Banks can't 'reach'. Some of these, which include selected currencies and bonds, currently have 'genuine growth potential';
  • past 'models' (I assume he means 'economic models') are broken, and new 'models' must be built;
  • the financial markets cannot disconnect from fundamentals forever, and in the end the financial markets will revert to the 'fundamentals' - with the result being severe capital devastation;
  • today the world is very binary, meaning it will either end well or very badly, without middle ground. Keeping options open and maintaining liquidity are the keys to surviving and profiting in a world of likely 'extreme outcomes'; and,
  • investors participating in today's financial markets need to mitigate risk pursuant to 'cost effective tail hedging'. Unhedged investors will pay a very high price for assuming 'excessive risk' when the financial markets revert to 'the fundamentals'.

Much of the foregoing is consistent with opinions I have expressed in this Newsletter in past months. I am particularly taken with Mr. El-Erian's views that:

  • past models are broken, and wonder if he shares my view that Central Bankers and many economists currently are relying on their 'book learned' beliefs that past economic events will repeat themselves in today's globalized world. This in circumstances where as I see things, there are fundamental differences between the world economy today (different dependancies, different ideologies, altering world powers, communications changes, etc.) and the world economy as it was up to as late as 1999. By analogy, would a baseball analyst predict the same average number of home runs hit in a season by all major league baseball players if a rule was introduced that all players had to hit with bats made of balsa wood. The obvious answer is 'hardly likely', or if he/she did that their forecast would be ridiculed and disregarded. I see a lot of economist 'hitting with balsa bats' these days;
  • the financial markets currently have reverted from 'honoring fundamentals'. I have said that a number of times, albeit slightly differently. This is something to seriously think about and reach your own conclusion if you participate in those markets; and,
  • the endgame is 'binary' with a likely outcome of 'one of two extremes'. This is an extremely important thing for everyone to think about - whether they participate in the financial markets or don't. It is definitely in my view something you should discuss with your investment advisor if you have one - and think hard about whether you do or don't have one.

My final comments:

  • hedging is complicated, and for a great many investors requires external advice. Hedging brings with it its own attendant risks;
  • in his conclusion, Mr. El-Erian describes the two 'endgame extremes' (my words) as (1) a return to organic growth, and (2) economic disaster - but says "the problem is we really don't knwo which it will be". I am surprised that Mr. El-Erian does express a firm opinion on which of the two extremes he believes most likely - although I have to believe he thinks the latter, if for no reason other than he seems to blame the 'market disconnects' on prevailing Central Bank policies; and,
  • because many of Mr. El-Erian's views are consistent with my own (and hence for me 'easy to agree with'), I suggest you read Mohamed El-Erian: Putting It All Together and reach your own conclusions with respect to what he says.

Topical Reference: Mohamed El-Erian: Putting It All Together, from Financial Sense, Lance Roberts, May 3, 2013 - reading time 5 minutes.

 

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