"El-Erian calls the present scenario 'stable disequilibrium.' Says he: 'There's no doubt that the world is in disequilibrium. You look at the U.S. household sector in terms of its negative savings. You look at how the real estate market has allowed people to sustain consumption by monetizing their equity. You look at the U.S. current-account deficit at 7 percent of GDP. You look at the fact that the poor countries are running surpluses and financing the rich countries. The surprising thing is that this disequilibrium is very stable, so risk premiums have shrunk and volatility has almost disappeared. What makes it stable is a sort of vendor financing relationship where the surplus countries - like China - find it in their interest to continue to invest in the U.S.' El-Erian says this stable disequilibrium may end in a crisis soon, or it may persist for a decade ... Here's his strategy regardless of how it plays out: 'Rather than speculate on two uncertain and extreme outcomes, we want to supplement the appropriate asset allocation with things that we know. We know that the Fed is nearing the end of the hiking cycle, so there's value at the short end of the yield curve - that if you can lock in at 5 percent two-year returns, that is a good deal with inflation running at 2 percent. We know that certain emerging economies have a tail wind behind them of high commodity prices and better fundamentals, that as long as one is willing to live through the hiccups, one is willing to take the volatility, they will continue to perform well. We're talking about countries such as Brazil and Russia, where you can see the international reserves going up. And finally you look at certain industries on the equity side that benefit from the current configuration, such as natural resources ... Focus on what you have confidence in and insure against the extreme - for example, through deep out-of-the-money put options on the S&P. That's not what most people are doing. Most people tend to flip-flop.'"
----(Fortune - "Hanging onto Harvard's $25.9 billion stash - Emerging-markets whiz Mohamed El-Erian takes over the world's biggest endowment fund" - 5/1/06 issue)
Schaeffer's addendum: I consider Andy Serwer's interview with Mohamed El-Erian in the current issue of Fortune to be a "must read."
"Stable disequilibrium" is by far the most accurate description I've ever seen of this market environment, and it goes a long way toward explaining how a low CBOE Market Volatility Index (VIX) can coexist with a multitude of risks to the economy and a multitude of geopolitical shock risks.
Mr. El-Erian recommends buying emerging markets and natural-resources stocks, while parking cash in short-term paper and insuring your downside with S&P puts. In other words, he's suggesting being long on so-called riskier momentum plays and short the mega-caps, while maintaining a cash reserve. I happen to be most comfortable with domestic small and mid-caps as my momentum plays, but I very much agree with Mr. El-Erian's investing philosophy.
Bernie Schaeffer
schaeffersresearch.com |
