Pimco’s Roadmap: Share the Pain
Too much, too soon for the financial markets?
That is the question the Mohamed El-Erian seems to be asking himself and the braintrust at Pimco.
Mohamed suggests the possibility, not the probability, that recent euphoric moves in equity prices and credit market spreads might be premature. The market’s justification may rest on the two-barreled conclusion that, 1) the delevering of the financial system is reaching a natural culmination as prices stop going down and banks and investment banks recapitalize their balance sheets, and 2) that numerous and previously unthinkable policy responses have restored enough liquidity to relubricate our finance-based economy. That may well be the case he counsels, but these are changes centered on Wall Street and "The City." Life on Main Street, U.S.A. and its English counterpart may be another matter. Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat and this recession, although currently mild and as of yet not even officially validated, may not be your garden-variety, father’s Oldsmobile-type of downturn. Pimco Market Letter
Indeed, even the most optimistic bulls at Barron's roundtable in January did not expect to see much in the way of a rebound until mid-2008. The recent rally might be a gift to sell into, while waiting out the healing process on both Wall Street and Main Street.
And Pimco has zeroed in on the biggest threat we face. Namely, asset deflation ignited by the housing market:
Because the U.S. and selected other economies are now substantially asset-based and dependent on stable and upward tilting prices, a deflation of an economy’s primary financial asset can be ruinous.
Pimco’s posture on the events of the past year are not popular within certain quarters; although their critics may have not taken the time to understand their stance before slinging arrows their way.
Pimco has played the game well over the past 18 months; they refused to participate in the popular, but dangerous trades many fixed income managers put on in 2006 and into 2007. But the break in the markets last summer vindicated their stance, and since they have been floating a series of trial balloons aimed at fixing what ails us.
Fed Funds have reached a level that Pimco argued for six months ago; we are now at the point where their most controversial proposal would be implemented:
Lower Fed Funds? They would, in PIMCO’s opinion, likely do more damage than good from this point forward. Foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result. The better alternative is to initiate a limited mark-to-market write-down of private mortgage debt as envisioned in the Dodd-Frank Congressional proposal combined with government-subsidized loans at below market rates. Look at it this way: you can allow a home to fall in price from $400,000 to $300,000 and force an upside-down “short sale” foreclosure, or you can reduce the homeowners’ $400,000 mortgage to $350,000, refinance the loan through the FHA at 4% and stabilize the neighborhood and its home prices. Surely Republicans, Democrats, AND Wall Street mortgage holders (PIMCO included) can recognize that stability as opposed to freefall market clearing is the better alternative, especially if the pain is shared by all parties. It is our best chance to cushion Minsky’s asset-based deflation.
Ben Bernanke’s moves will be endlessly debated in the months ahead, but it will be years, if not a decade, before history has the opportunity to judge his ultimate success. You can enter the firefight, although it will not necessarily pad your bank account.
Perhaps Bill Gross’ parting words are his most valuable. at least for pragmatic investors who have rocky shoals to navigate:
Remarqure wrote of his WWI soldiers: “We live in the trenches…we fight. We try not to be killed. Sometimes we are. That’s all.” At PIMCO, with a much less dangerous but perhaps equally probabilistic occupational outcome, we will keep our heads low in hopes of fighting for another day.
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Pimco Investment Outlook
May 2008
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No Position
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