PIMCO CEO and Co-CIO Mohammed El Erian was out with his secular outlook recently and a followup piece in the journal of indexes redefining what the famed “new normal” will look like forward. As the piece is 7 pages long I thought I would give our readers a summary of what I feel are the most important points for investors.
For anyone who is not familiar with the new normal here it is in PIMCO’s own words:
The new normal was meant to convey the notion that, for a host of reasons, economies would not reset in the traditional cyclical sense. Instead, absent a material change in policymaking and its mindset, the West was facing the unfortunate probability of several years of unusually sluggish growth, persistently high unemployment, and periodic debt and deficit concerns.
Basically, the theme of the new normal is that this time it is different, and that instead of the cyclical upswing in growth that has occurred after prior downturns, we were going to be stuck in the trough for quite some time.
According to Mohammed the new normal is now morphing into something different, which is best characterized as a “stable disequilibrium”. Many of the major economies in the world are now fast approaching a T in the road with the possibility of “two quite distinct and contrasting outcomes thereafter.”
So how do we know whether the US and other economies are taking a right turn towards a pickup in growth and prosperity or a left turn to continued sluggish growth and potential further economic instability?
By watching the answers to the following three questions:
- Does Europe take a right turn by pursuing a closer and more complete union which can deliver faster growth to the majority of its members, or a left turn towards a messy reorganization?
- Does Japan take a right turn by backing up the extraordinary central bank intervention with the implementation of structural reforms, while at the same time receiving continued tolerance on the part of its main trading partners? Or do they take a left turn by not implementing those reforms and/or seeing their trading partners turn more hostile to their weak yen policy.
- Does the US take a right turn towards increased growth and stability with our political leaders in Washington beginning to work together to resolve their differences and begin to become a tailwind for the economy instead of a headwind? Or do we take a left turn with continued or further dysfunction in Washington?
The investment implications of the new “new normal” are significant.
Up to this point, the Fed and other central banks have been so active in the markets that investors could profit handsomely by ignoring the underlying fundamentals and simply focusing on following the central bank money. On this strategy Mohammed warns:
Look for the effectiveness of this theme to be increasingly challenged as the new normal morphs into a stable disequilibrium.
So what is an investor to do? One of the things I like best about PIMCO is that they not only give their opinion about what they think the future holds but also action points on how investors should cope.
Here are the 7 action points for investors taken from the piece:
Investors should gradually “kick out” from riding a central-bank wave that will prove more unstable and less effective.
They should focus on investment opportunities away from the wave: those associated with its “costs and risks,” and those that arise from the inevitable technical overshoots that will occur in certain markets (particularly those subject to considerable but volatile crossover investment interest, including segments of emerging markets).
They should expect asset-class variances and covariances to become more volatile and less predictable.
They should be more cautious in their expectations of risk-adjusted returns going forward.
They should evolve their risk management to extend well beyond asset-class diversification, including cost-effective tail-risk hedging where appropriate.
Given that the world is changing, they should guard against falling hostage to outdated benchmarks, guidelines and investment labels.
Finally, they should resist the illusionary safety of old comfort zones, and do so through greater awareness of the limitations imposed by inadequate framing, unconscious biases, active inertia and overly narrow cognitive diversity.
What do you think about the new “new normal” and how do you plan to position your portfolio?