Still, the primary way to coin money over the past 30 years has been to use money to make money. Although the price of it started in 1981 at a rather exorbitantly high yield of 15% for long-term Treasuries, 20% for the prime, and real interest rates at an almost unbelievable 7-8%, the gradual decline of yields over the past three decades has allowed P/E ratios, real estate prices and bond fund NAVs to expand on a seemingly endless virtuous timeline. Books such as “Stocks for the Long Run” or articles such as “Dow 36,000” captured the public’s imagination much like a Montana to Jerry Rice pass that always seemed to clinch a 49ers victory. Yet an instant replay of these past few decades would have shown that accelerating asset prices weren’t due to any particular wisdom on the part of academia or the investment community but an offensively minded Federal Reserve and their global counterparts who were printing money, lowering yields and bringing forward a false sense of monetary wealth that was dependent on perpetual motion. “Rinse, lather, repeat – Rinse, lather, repeat” was in effect the singular mantra of central bankers ever since the departure of Paul Volcker, but there was no sense that the shampoo bottle filled with money would ever run dry. Well, it has. Interest rates have a mathematical bottom and when they get there, the washing of the financial market’s hair produces a lot less lather when it’s wet, and a lot less body after the blow dry. At the zero bound, not only are yields rendered impotent to elevate P/E ratios and lower real estate cap rates, but they begin to poison the financial well. Low yields, instead of fostering capital gains for investors via the magic of present value discounting and lower credit spreads, begin to reduce household incomes, lower corporate profit margins and wreak havoc on historical business models connected to banking, money market funds and the pension industry. The offensively oriented investment world that we have grown so used to over the past three decades is being stonewalled by a zero bound goal line stand. Investment defense is coming of age.

PIMCO Offensive Strategy 1981 – 2011

Ready, Set, Hut 1, Hut 2 –
Recognize downward trend in interest rates and scale duration accordingly.

A. Emphasize income and capital gains. PIMCO Total Return Strategy.
B. Utilize prudent derivative structures that benefit from systemic leveraging – financial futures,
swaps (but no subprimes!)
C. Combine A and B along with careful bottom-up security selection to seek consistent alpha.

PIMCO Defensive Strategy 2012 – ?
Ready, Set, Hut, Hut, Hut –

Recognize zero bound limits and systemic debt risk in global financial markets. Accept financial repression but avoid its impact when and where possible.

A. Emphasize income we believe to be relatively reliable/safe.
B. De-emphasize derivative structures that are fully valued and potentially volatile.
C. Combine A and B along with security selection to seek consistent alpha with admittedly lower nominal returns than historical industry examples.

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