Commentary from the 2010 Morningstar Investment Conference
Inflation is coming, but when?
Pat Dorsey, when asked about gold said, “all I know is that it is shiny.” The metal has been looked at in the past as a hedge against a weak dollar and inflation, but Dorsey suggests that with the emergence of ETFs that track the price of Gold, the yellow currency may be over inflated because of the ease of entry.
Dorsey also had this to say in regards to when inflation will occur, “We have never been here before and we just don’t know if we will see inflation or deflation short term.” When advisors were asked if they expected inflation in the next 12 months, none of them raised their hands, but when they were asked if inflation would be an issue in the next 20 years they all agreed that it is unavoidable.
Because inflation is looming, but not expected right away, inflation protection is relatively cheap. The challenge will be to take advantage of the price without being negatively impacted by deflation or rising interest rates.
There is a bond bubble, but it may not pop quite how we expect.
Curtis Arledge is Blackrock’s Chief Investment Officer of fixed income. “The bubble is real,” he said, “but it is made up of very safe and short term investments.” Earlier I mentioned that nearly one half of a trillion dollars has flowed into bond funds in the past 18 months. Curtis and a few other bond fund panelists agreed that the majority of this money has moved into ultra-safe investments, thus setting this bubble apart from the dot-com bubble and the housing bubble.
Curtis re-emphasized the bond panelists concerns, “consumers are missing an opportunity to lend while demand for credit is high and banks are not lending.”
This money will flow out of bond funds eventually, but investors will miss out on opportunities while they wait. We have been trying to put money to work in accounts, looking to alternative strategies and de-valued bond funds. We have never been in a place where interest rates were so low for so long and government spending so high. We are working to find opportunities for conservative allocations but are concerned about principle preservation as well.
The next decade in your portfolio does not have to resemble the last.
The last ten years has been labeled by investors as, “The Lost Decade.” Rob Arnott, a fund manager for PIMCO All Asset suggests that, “the past decade was only a lost decade to investors who were 100% in equity and weighted by market capitalization.” In plain English, if you were invested in the S&P 500 you would be flat for the decade. The S&P 500 is market weighted. This means that if you own the index, the majority of your holdings are focused on the largest and MOST EXPENSIVE companies. In the same way, if you owned a bond index you probably owned the MOST INDEBTED countries and companies.
Well, grandpa always said to buy low and sell high. Arnott suggests that folks who did not blindly purchase indexes should have performed better over the same time period. Arnott says to, “Use your risk dial. If I am not getting paid to take risk, I don’t want to take risk.”
For a decade that saw the emergence of the ETF, this flies in the face of many new beliefs. We believe Arnott has a strong point. Although we have done our due diligence for investors regarding passive investing and ETFs, it seems that so far, good managers who understand risk have been able to add value throughout a lost decade.
This was a good trip and a great chance to sit with many of the managers that we work with. Our goal is to make sure that they are adding value, picking good holdings and avoiding bad ones. These managers cannot see into the future, they don’t know where the markets are headed exactly, but overall they are looking for themes, just like we are. We are always happy to entertain questions or have discussions on these topics.