- Investment managers like the infamous Madame Rue sells hope instead of love but very few are able to seal the deal with performance anywhere close to compensating for the generous fees managers command.
- Hope has a legitimate price even if its promises are never fulfilled. It is why we put donation into the collection plate on Sunday mornings and why we risk money at the blackjack table. When promises are not fulfilled, we rationalize it as insurance in the former case and entertainment in the latter.
- Industry as a whole cannot outperform the market because they are the market and yet investors are willing to pay the generous fees to fund managers.
- Based on the new normal of 6% return that PIMCO envisioned, a 1% management fees paid by investors to funds equate to a 15% extraction of investors' income.
- Investors looking for hope in a deleveraging and reregulation economy must focus on some macro-oriented events rather than focus on typical news-dominated details.
- Common sense tells us that consumer spending growth comes from highly employed, well-compensated labor, and we are far-far from even approaching that elemental condition. In reality, near double-digit unemployment has resulted from numerous business models that are now broken: autos, home construction, commercial real estate development, finance and retail sales.
- Reflecting nominal GDP by inflating asset prices is the fundamental, yet infrequently acknowledged, goal of policymakers. If they can do that, then employment and economic stability may ultimately follow.
- Nominal GDP over the last 15 years increased 5-7%.
- 5% was the number capitalists rely on to justify employment hiring, investment spending plans and also serve as a close proxy for the return on capital that they should expect.
- Nominal GDP is in fact a decent proxy for a national economy's return on capital which serves to estimate the present value of cash flows, and price investment and related assets accordingly.
- Businesses' growth in demand, expenses and return on the economy's capital would mimic this 5% consistency. Debt was issued with yields that reflected the ability to service those payments through 5% growth in both real and inflationary terms, and stocks were issued and priced as well with the same foundation. So are pension obligations and similar liabilities, as well as government spending programs forecasting tax revenues and benefits.
- However, things have changed. Nominal GDP sunk below 5%. If this continues, a portion of the U.S. production capacity - massively overcapacity now as it is catered for 5% growth - and labor market will have to be permanently laid off.
- Economy may head towards a new normal where unemployment averages 8 instead of 5%, housing starts total 1.5 instead of 2 million, domestic auto sales 12 instead of 16 million annual units, if nominal GDP does not grow close to 5% so that long-term balance is to be maintained.
- Debts are haircutted via corporate defaults and home foreclosures and equity P/Es are cut based upon increase risk and substantially lower growth expectations, during the readjustment process.
- A modern capitalism economy based on levered financing and asset appreciation cannot thrive if its "return on capital" or nominal GDP suffers such a significant shock.
- Government interventions - low interest rates, quantitative easing, $1.5 trillion deficits - are not likely to successfully reflate to 5% nominal GDP growth. Substitution of government-backed vs private-leverage works against the possibility.
- Low rates financing provided by the TALF, TLGP, etc., comes with quality constraints (larger collateral haircuts and mortgage down payments, to name a few) that inhibit the "new normal" lenders from approaching the standards of the 5% nominal-based shadow banking system.
- "New normal" will likely be closer to 3%, for at least a few years. Diminished capitalistic risk taking and constrained policymaker releveraging will lead to this conclusion.
- A 3% nominal GDP "new normal" means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector, which substantially changes the character of the American capitalism model.
- A readjustment to 3% nominal GDP means default/haircuts for assets on the upper end of the risk spectrum, as well as extremely low yielding returns for government and government-guaranteed assets at the bottom end.
- Steady income-producing bond and equity investments in companies with strong balance sheets and high dividend yields is recommended for this new environment.
Friday, July 31, 2009
Bill Gross August 09 Investment Outlook Notes
Here are notes from Bill Gross's Aug 09 Investment Outlook article: