PIMCO - Economic Outlook May 2011

http://www.pimco.com/EN/Insights/Pages/Secular-Outlook-Navigating-the-Multi-Speed-World.aspx#

Mohamed A. El-Erian

Secular Outlook:
Navigating the Multi-Speed World

• ​Balance sheets, both across and within economies, are still out of equilibrium. We expect advanced economies will face sluggish growth and persistently high unemployment over the secular horizon. Emerging economies will achieve higher growth but face recurrent inflationary concerns.
• We do not expect policymakers to boldly address structural problems. By targeting negative real interest rates, they will pursue financial repression that undermines the “real return” contract that savers expect.
• Secular baseline portfolio positioning should minimize exposure to the negative impact of financial repression, hedge against higher inflation and currency depreciation and exploit the heightened differentiation in balance sheets and growth potentials.

Colleagues from around the world gathered last week in our headquarters in California for a PIMCO tradition that is almost 40 years old: Our annual Secular Forum – an occasion when we temporarily leave behind high frequency and cyclical issues and, instead, actively debate what the next three to five years hold for the global economy and markets.

As many of you know, the Forum is one of the pillars of our investment process. It speaks to both what and how we think. It reduces the risk of cognitive capture and active inertia. And the output informs in multiple ways our approach to delivering value to our clients around the world.

​PIMCO 2011 Secular Forum Speakers	​
​The Rt. Hon. Gordon Brown, British Member of Parliament; former Prime Minister (2007–2010) and Chancellor of the Exchequer (1997–2007); author of “Beyond the Crash: Overcoming the First Crisis of Globalization”	​
​Mark Halperin, TIME magazine editor-at-large and senior political analyst; author of the New York Times #1 best-seller “Game Change: Obama and the Clintons, McCain and Palin, and the Race of a Lifetime”	​
​Dambisa Moyo, economist; former consultant to the World Bank; author of two best-sellers, “Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa” and “How the West Was Lost: Fifty Years of Economic Folly – and the Stark Choices Ahead”	​
​Gillian Tett, U.S. managing editor of the Financial Times; winner of the British Press Awards 2009 Journalist of the Year; columnist; author of “Fool’s Gold: The Inside Story of J.P. Morgan and How Wall St. Greed Corrupted Its Bold Dream and Created a Financial Catastrophe”	​

 

Once again, we had the privilege of listening to four  excellent outside speakers (see right). They were chosen for their expertise, experience, and diverse perspectives and frameworks; and they did not disappoint. Their presentations were thoughtful, stimulating and entertaining. 

 

We also maintained the wonderful custom of giving the stage to our brand new hires to hear their views on what the firm should be thinking about in defining its broad course for the next few years. They too excelled, providing great insights and comprehensive analysis.

All this encouraged a wide-ranging and, at times, heated discussion that encompassed many issues – economic, political, demographic, scientific and social. Remember, PIMCO’s Secular Forum takes a “long term” view (which, for market participants, means a three- to-five-year horizon). It is global in nature. It is about what is likely to happen rather than what should happen. And its main characterization is, of course, re-examined periodically during the year as new information and analysis become available.

My objective here is to try to summarize for you the key issues that emerged during 2½ days of discussion, and several months of preparation and analysis. While I regrettably recognize that I will fail to do justice to the depth of the insights and interesting exchanges, I hope to capture for you the main points and some of the nuances.

That’s not all I am hoping to do. As Bill Gross often points out, we are not in the business of buying and selling GDP notes around the world. Instead, we invest across the capital structure, and across borders and sectors. So it is about all types of bonds and equities, commodities, currencies, volatility, etc…. Accordingly, the discussion will also be linked to broad principles underpinning investment positioning over the secular period.

This linkage of the Forum to our secular investment strategies is very important. It speaks directly to key multi-year themes and related guard rails. Together with cyclical, structural and tactical considerations, this determines the way we position the pensions, investments and savings which you have entrusted to us to manage on your behalf.

While this is the main way in which the Forum impacts our daily delivery of value to you, it is not the only one. It also influences how we approach client interactions, product/solution design, thought leadership, and business management. But these are for another occasion.

With this preamble, the rest of this summary note is organized in three main sections: the context for the discussion, the main findings, and the investment implications.

The Context
In the two Secular Forums that followed the collapse of Lehman Brothers,¹ we postulated that the world would have difficulties resetting in the traditional cyclical manner. Instead, it faced a protracted journey involving major, multi-year national and global re-alignments; and the destination would differ in some important respects from recent historical precedents.

We attempted to capture all these complex issues by the simple phrase “a bumpy journey to a new normal.” We argued that the process would involve two distinct sets of dynamics: Advanced countries  – and particularly the finance-dependent ones (and, importantly, the U.S.) – would experience unusually sluggish economic growth, persistently high unemployment, public debt and deficit issues, increased regulation, and continuous pressures for private sector deleveraging. Meanwhile, emerging economies would maintain their development breakout phase, registering high growth rates and continuing to close the income and wealth gap relative to advanced economies.

In painting this medium-term picture, we also acknowledged issues of stability – or to be more specific, potential instability. Indeed, the image that came to our mind last year was that of a car traveling on a bumpy road, to an uncertain destination, and driving on a spare tire.

Part of the three- to five-year secular horizon has elapsed and developments have been consistent with this new normal characterization. For example,

•  The ongoing G-7 recovery is relatively sluggish, both in overall terms and relative to history (Figure 1);
  
   
• The unemployment rate in the G-7 has surged and, despite a fall in the labor participation rate in some countries, now exceeds that of emerging economies (Figure 2);
  
   
• Deficit and debt indicators have worsened significantly, in absolute terms and relative to emerging economies (Figure 3); and, in a major change for those that remember the old days,
  
   
• The average market risk spread on advanced economies now exceeds that on emerging economies (Figure 4).
  
   

These realities are playing out notwithstanding bold policy reactions in advanced countries aimed at mitigating them and delivering a more “normal” recovery. Indeed, for most of the post-crisis period, policymakers (particularly in the U.S.) have been fixated – and understandably so – on stimulating growth through aggressive fiscal and monetary policies. Indeed, some policymakers have even embraced explicit initiatives to boost asset prices, driving a significant wedge between economic fundamentals and turbo-charged asset valuations.

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