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How to cope in a riskier world

Fri, 19 Oct 2012

How to cope in a riskier world
A one-hour session with Pimco’s Scott Mather makes you realise how isolated – not to say insulated – the local media and their information-seeking public are from the forces engulfing the world economy.

This isolation lies in the “you don’t know how lucky you are” category but it less about luck than unacknowledged success in financial management.

Yet the media think the public are more interested in the prime minister’s memory “gaps” on Kim Dotcom than in explaining why the head of one of the world’s largest money managing outfits would bother coming here at all.

Certainly, Mr Mather’s views as head of global portfolio management carry far more sway economically than New Zealand’s entire clout.

Pimco, or the Pacific Investment Management Co, based in California, runs the world’s largest bond fund worth hundreds of billions of dollars.

It has been stocking up on bonds in New Zealand and Australia for no better reason than that these countries are now among the world’s best managed and performing economies.

Unfortunately, this message to the public, and its political endorsement, is lost amid reports of government failure, Reserve Bank mismanagement and corporate incompetence.

The good news
Yet note Mr Mather’s observations:

• The [kiwi and the aussie] currencies are no longer commodity based and subject to risk-on, risk-off sentiment; they are now regarded as “flight to safety or quality.” In other words, securities held Down Under are regarded as gold-plated on the world scene, an unprecedented achievement and should be a matter of national pride.

• The debt situation of New Zealand and Australia, along with a handful of others such as Canada, Mexico and the Nordic countries, are the best in the world. Pimco’s analysis includes both private and public debt as well as assessments of those countries’ future commitments and level of entitlements. In other words, these will be safe havens for some time.

• Policies and interventions that interfere or distort markets, adding to instability, are absent from the New Zealand and Australia, thanks to sound centralist government. This contrasts with countries where populist governments have raised trade barriers, debased their currencies or started subsidising industries and jobs.

(These policies, of course, are advocated here and heavily promoted by an unrealising media. But whose judgment would you value most managing your money: Mr Mather and John Key – or Winston Peters or Russel Norman?)

The depressed global scene
This snapshot of how Mr Mather sees New Zealand’s place in the world is persuasive enough that these subversive voices should somehow be silenced or ignored. But he is just as convincing when explaining the global scene and whether New Zealand should follow an alternative path.

His short answer: “The world is much riskier than at other times.”

Why that is the case: The world economy is slowing more than expected – Pimco has downgraded its forecasts to 1.5-2.0% over the next 12 months, with 1.25% in the US and a 1.5% drop in Europe.

There is a high chance a further upheaval in Greece will send another shock through the already recessionary European economy.

Interest rates are likely to ease further in countries where they are high (such as New Zealand) while the effects of further money printing (or quantitative easing) by the US and others are diminishing with each round.

Mr Mather is not prepared to condemn this policy, saying the alternative would be a collapse of the US economy and a catastrophic drop in demand that would imperil all other economies.

At the same time, he says loose monetary policy is a growth inhibitor: it keeps debt high and wages down (other reasons why New Zealand should avoid this path). Longer term it degrades human and other capital assets (though unemployment and under-investment) and can lead to rapid inflation when the economic cycle turns.

Diminished investor expectations
Meanwhile, and this could be the biggest take from the Mather session, the biggest impact might be pressure on long-term investor expectations.

These are lower than they’ve even been and are partly due to causing a boom in sharemarkets – a surge Mr Mather thinks has been overdone.

Stocks are being purchased on higher multiples while earnings are declining. The search for higher yields when interest rates are near-zero has raised unrealistic expectations of shares.

It is normal to assume equity markets are over-heated when  promised returns are higher than their earnings can justify. In turn, this across-the-board reduction in returns to lower than normal often leads to risky or short-term behaviour.

This is where politics can intrude. Mr Mather says there are still opportunities for actively managed funds – but not where you might expect.

The bond market is dominated by the actions of central banks. Driven by political edicts, they often throw up opportunities for savvy investors.

“There’s nothing like having participants in markets who sometimes act on a non-rational economic basis,” Mr Mather says.

Messrs Peters and Norman fall into that category: beware if their advice is followed as it will only be people such as Mr Mather who will benefit.

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How to cope in a riskier world