Despite the fact we avoid using economic forecasting to build our portfolios, I found myself appreciating comments that Mohamed El-Erian made recently at a CFA fixed income conference on central banks, behavioral finance, economic modeling, and investment portfolios.
Mohamed El-Erian needs no introduction to most. He was the CEO of PIMCO, spent many years at the International Monetary Fund, and ran the Harvard Endowment Fund. Recently El-Erian spoke at a CFA fixed income conference. He is clearly very knowledgeable, has access to the top economic and policy making minds, and perhaps most importantly is a practitioner.
El-Erian is also well-known for describing the post-2008 low interest rate environment wherein economic activity remains sluggish and unemployment high for a prolonged amount of time. In this conference, he further argues that the monetary and fiscal policy decisions made in such an environment go a long way towards deciding which direction a more permanent recovery takes. With the right combination you get broad economic recovery. But without a coordinated effort between central bankers and lawmakers, it is continued sluggish growth.
El-Erian begins his talk with an assessment of central banks, especially of our own Federal Reserve. The 2008 crisis forced the hand of the Fed into aggressive monetary policy tactics. El-Erian gives Bernanke and team an A+ for this first quick reaction. Without the immediacy of the Fed’s actions, 2008 would have been a protracted depression with generational affects.
Grading the Fed post-2008 is more difficult and can’t be done without including the rest of government on the report card. Monetary policy alone is not the right tool for durable growth. It serves to stimulate a wealth effect, Keynes’ animal spirits. But without the structural reform and smart government spending that comes from coordinated fiscal policy, the overall economy will not be as healthy as it could be.
El-Erian then postulates that such a divergent set of outcomes creates challenges for investing and building portfolios. It certainly does! Equity markets have gone through the roof on the back of earnings growth since 2008 and sluggish GDP figures don’t seem to have anything to do with it.
Markets have always created unexpected conditions with outcomes both much better and much worse than expected. In fact, we can’t envision a market scenario that doesn’t create investment challenges; no environment that doesn’t necessitate a unique approach to diversification and portfolio construction.
So as much as I might think El Erian’s economic overview insightful, our investment process is not dependent on getting such a view correct. And therein lies the key to how KilterHowling does things.
All the best things in life involve a tradeoff. At KilterHowling, we balance active and passive investing, valuation and tactical approaches, quantitative with qualitative processes, and ultimately risk and return so that we don’t have to be right regarding our economic outlook. Simple diversification by asset class just isn’t enough. El-Erian himself agrees and offers some similar suggestions at the end of his talk – we’ll have to check the log to see if he has been reading our website!
Please follow the link below, if you would like to listen to Mohamed El-Erian’s comments – I certainly enjoyed it: