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El-Erian: 8 Themes for Long-Term Investors In the 'New Normal' Markets


Whether it is due to a lack of understanding, a political system that is not at all agile, or the imperfect remedies that current policy offers, ordered chaos has become the norm.

Editor's note: This article by Mohamed A. El-Erian, CEO of PIMCO, originally appeared on PIMCO.

Maintaining an approach that has served PIMCO's clients well for four decades, our investment professionals gathered in Newport Beach last week for three days to discuss the three- to five-year outlook for the global economy and markets. Again, we were privileged to hear the insights of global thought leaders and experienced practitioners from outside PIMCO (see box below), as well as our new (and really impressive) class of MBAs and PhDs.

As you can imagine, we covered quite a few themes: from the hyperactive role of central banks to quite dysfunctional politics, from increasingly influential demographics to unusual economic and financial configurations, and from exciting innovations to disturbing income inequalities and social tensions. Yet with the anchoring role of PIMCO's 2009 concept of a multi-speed New Normal (yes, it has played out as anticipated), we managed to converge on a three- to five-year outlook for the global economy – not as an end in itself but, rather, as a means to specify longer-term investment themes.

Think of this annual "Secular Forum" as providing the medium-term guardrails for how, where, why, and when we invest the funds that you have entrusted to us. It informs and influences the positioning of our commodity, currency, equity, fixed income, and multi-asset strategies (in terms of beta and alpha generation, as well as risk management approaches). Needless to say, the findings will be supplemented by the conclusions of our next quarterly Cyclical Forums, the four-times-a-week meetings of the Investment Committee, and high-frequency interactions among colleagues in our 13 offices around the world.

I must admit that, going into this year's discussions, I found the context even more challenging than usual. Indeed it was the most complex since I first joined PIMCO in 1999.

This complexity is not just due to a global economy in the midst of multiple historical realignments. It is also because highly experimental central bank policies have disconnected most asset prices from the complex ecosystem. Fortunately, I was helped by insightful presentations, robust discussions and remarkable inputs from talented colleagues. So, starting with a bit of context, here are our major findings and broad investment implications.


A prior Secular Forum concept – that of a "New Normal" involving unusual and persistent multi-speed dynamics within and across countries – again proved valuable in anchoring our starting point. Indeed, the concept has become so mainstream by now that, just last month, Christine Lagarde, the managing director of the International Monetary Fund, used a "three-speed world" to frame the conversation for officials gathering in Washington, DC, for their semiannual policy discussions.

A relatively robust set of fast-growing emerging countries (led by China) has continued to act as the locomotive for the global economy. From a GDP perspective, they have been compensating for the slowest Western economies mired in unsatisfactory growth – first Japan and now, to a greater extent, a growing part of Europe. In the middle is a healing US economy where an increasing number of sectors have rehabilitated their balance sheets but have yet to collectively reach escape velocity.

This elegant "three-speed" characterization featured prominently in our discussion. And the critical question that kept on surfacing was if, when and how it would transition in the next three-five years, with particular emphasis on growth dynamics and related aspects of financial stability, cross-country interactions, and the impact of inequality and political dysfunction (see Figure 1 for an illustration of the major potential medium-term handoffs).

Needless to say, the role of central banks came up a lot in our analysis. By venturing deep into experimental policy territory, and by remaining there for quite a while, central banks have tried to support growth and counter financial instability, thus buying time for economies to heal endogenously and for politicians to deliver on their policy responsibilities. In the process, they have inserted a remarkable wedge – a disconnect – between market prices and underlying economic and financial fundamentals.

Despite their innovative and courageous efforts, central banks are still unable to deliver sufficiently robust growth and jobs to Main Street. But they have been investors' best friends.

Their unprecedented policy activism (including, most recently, Japan's boldest post-war economic policy experiment) has – to use Bill Gross's southern Californian analogy – induced the vast majority of investors to grab their risk surfboards and ride a large and growing wave of global liquidity.

Investors are enticed to take more and more risk at ever more elevated prices. Most see no need to kick out of the wave anytime soon; and quite a few believe that, if it eventually breaks, it will do so gently, delivering investors to a world where improving fundamentals validate and push even higher asset prices initially rendered artificial by unconventional policy actions.

By seeking to lessen the twin problems of deficient aggregate demand and structural impediments, and by financing debt problems, central banks have delivered investors a down payment on future growth and future returns. Well, that is the hope and intention. But if growth fails to materialize over time, reality will snatch back the returns from investors in the period ahead.
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