What lies ahead? That was the topic addressed by a panel of market experts on June 26 at the 2003 Morningstar Investment Conference in Chicago. Moderator John Rekenthaler of Morningstar said that while getting compensated is an area of concern for advisors, it is important not to lose sight of some of the bigger issues surrounding the markets and portfolio construction.
“When you get enough basis points in your favor you’ll do well,” Rekenthaler said, “but we cannot forget the big picture issues like the crash of 1987, the junk bond crisis, the insurance crisis, rising inflation, the Dogs of the Dow, the Asian crisis, the late 1990s, and the not-so-pleasant market of ’01, ’02, and ’03.” Or the “Dear Market” as Rekenthaler referred to it
The panel included Daniel Fuss, portfolio manager for Loomis, Sayles & Company, Paul McCulley, managing director and head of PIMCO’s short-term desk, and Byron Wien, managing director and senior investment strategist for the U.S. at Morgan Stanley.
Fuss began his comments by making a short-term prediction. “I’d sell everything right now, and [yet] my theme today is “hanging on to what you’ve got,” he joked. According to Fuss, three things will change for investors in the U.S. in the near future: both fiscal security and the government are going to become a greater part of everyone’s life; second, the world’s population will continue to grow, but not in every region; and third, the economy will boom in areas like China, India, and Southeast Asia but regions like Japan and Europe will continue to struggle.
“In bonds, we are going to live with the current yield curve for the next year, but beyond that I don’t like the outlook,” he said.
“I think the economy is going to strengthen and inflation will rise. We are going to come out of this with moderate inflation and later deal with a much higher rate of inflation.” So in running a bond portfolio, maintaining the unit values through this roller coaster is a source of concern.
McCulley agreed with Fuss and added that in the 1980s and the 1990s the government was in retreat while capitalism was in a bull market. The shift in power from the government to private sectors kept the bull market booming, he argued. But that has ended. “Capitalists gave us triple bubbles, and that was brutally self defeating,” he said.
McCulley also argued that the Federal Reserve conducted a 20-year war against deflation and won. “The Fed is embarked on a new war of opportunistic reinflation. They want a higher inflation rate,” McCulley said. But those two developments–the end of the bull market and deflationary risk–are a nasty combination, he warned. The Fed is creating a bubble in the Treasury bond market. And inflation will inevitably rise again, he predicted. “It is time for us to remember how to win from higher inflation and not lower inflation.”
Wien, unlike his predecessors, delivered his predictions with less of a Doomsday air. “Fiscal and monetary policy will [become stronger] and earnings for the remainder of the year will surprise you,” he said. But his bigger concern is manufacturing. “America is the leading country in the world and yet we don’t make anything anymore. We are addicted to foreign-made goods. When the economy slowed, we still had a trade deficit: that is our most serious problem.”
The second biggest problem is that trust in this country has been broken over the last few years by continuing corporate scandals. “When the trust covenant is broken, it has an effect on the markets,” Wien argued. Additionally, terrorism has altered investors’ sense of well-being.
Finally, “We are in a deflationary circumstance and we are working very hard to get out of it. You have every force trying to move interest rates higher, and a recovery is imminent. Sometime next year, rates will move up, so this is hardly the time to lengthen your maturities.”