February 2011

February 25, 2011 04:45 p.m.
Gundlach, Gross and More

Events in North Africa and the oil markets dominated the last week’s news. Our portfolios have held up well because of their diversification and hedging, so we don’t need to make adjustments until we get a better idea of how events will play out longer term. In the meantime, there are some other items I want to make sure you didn’t miss.

Jeffrey Gundlach’s skills no longer are a secret. The manager of DoubleLine Total Return was on the cover of Barron’s edition on Monday. (Subscription might be required.) The interview shows Gundlach’s immodesty and self-promotion as well as his investment record.

Gundlach currently is bearish on pretty much all investments except the mortgage securities that make up most of the DoubleLine Total Return portfolio. He’s particularly bearish on stocks and tax-exempt bonds. In fact, he anticipates that closed-end tax-exempt bond funds will sell at 40% discounts to their net asset value in the next year or so. He sees a seller’s panic driving down the tax-exempt market. Learn more about Gundlach’s overall views, the composition of the portfolio, and his litigation with former employer TCW in the article.

Also of interest in this week’s Barron’s is a piece on PIMCO Unconstrained Bond fund. I’m taking a close look at this fund these days. I initially was considering it for the “hedge fund” portfolio but also am considering it for the other portfolios. Read the piece if you want to learn more details. (Subscription might be required.)

The rich are different from other people. You don’t need scientific research to tell you that. But in case you do, or want to see one that re-enforces this view, here’s one from The Wall Street Journal Wealth Blog that says the wealthy have more energy and focus that energy on tasks that tend to generate more wealth.

It’s always a good idea to read Bill Gross’s monthly essays on PIMCO’s web site. This month’s edition takes an unusually broad view of the financial world and is extremely cynical about his own profession and current government and Federal Reserve policies. Gross believes, as I’ve stated in the past, that policies are punishing savers and conservative investors in order to benefit (or save) banks and other leading financial institutions. Keeping interest rates extremely low also is encouraging the extreme levels of leverage, which is likely to cause more of the dislocations and imbalances that triggered the recent crisis. He’s recommending, as he has for a while, broadening your view of the investment universe. He’s especially fond of emerging market debt and currencies in countries that aren’t highly leveraged.

February 17, 2011 11:10 a.m.
Food and Inflation

It’s looking like 2008 all over again. You might recall that before the Lehman Brothers bankruptcy almost brought the markets and the global economy to their knees, prices of some commodities were skyrocketing. At the time oil and energy prices were the big problem. The prices caused a lot of social unrest, especially in the U.S., and harmed economic growth. People also were worried about a new wave of inflation triggered by these rising prices. It turned out the increases were temporary, speculative bubbles. They were partly the result of money fleeing other assets to settle in commodities. I also think a good part of the surge was due to China stockpiling inventories before the Olympics that year.

Now, we face another surge in commodities. This time food and agricultural prices are leading the way. Rising food prices are blamed for triggering a large part of the uprisings in northern African and Middle East countries. Higher food prices trigger two questions. What is causing the price increases? What are the follow-through effects?

There are several likely causes of the rise in agricultural prices.

 Economic growth in emerging economies naturally leads to rising demand for food and agricultural products. It’s a normal part of economic growth. The emerging economies have been growing rapidly for some time, outstripping growth in developed markets. Various international statistics show that demand for many agricultural commodities has increased.

 Weather’s been a problem. Droughts, freezes, and other weather events reduced output of various agricultural commodities. So, supply declined while demand was increasing.

 Some producing countries respond to the global conditions by reducing the amount of their own supplies that they’ll export. Some are holding inventory in hopes of selling at higher prices in a few months. Others are concerned about having enough or their own populations at reasonable prices, so they’re restricting exports.

 Monetary stimulus also has been blamed for rising commodity prices. It’s no secret that central banks around the globe have increased money supplies to counteract the effects of deleveraging in the developed world. A lot of this money has found its way into commodities as well as financial markets. It’s interesting that agricultural prices increased just as emerging stock markets had corrections. Perhaps some investor money flowed from overvalued stocks to commodities, as happened in 2008.

I believe the major causes are the increased demand from growing economies coincided with reduced supply from weather and other forces. The reduced supply from the weather effects could be temporary, but because of production cycles it could be a year before new supplies are brought to market. The increased demand from economic growth will continue unless there is a global recession. While the price increases for commodities could slow, higher demand for them is likely to continue and will push prices higher unless supplies increase.

What are the likely effects, other than temporary price increases? You’ll recall that in 2008, just as analysts were predicting a steadily, unending upward move in oil prices, they peaked at around $147 a barrel and haven’t approached that level since.

It’s important to realize that increases in one or a group of products, such as commodities, can’t lead to overall price inflation. General price inflation comes from increased money supply coupled with steady or increased velocity of money. Without increased money supply, higher prices for one item mean consumers will buy less of another item or do without. The Fed has been using monetary stimulus, but that’s largely to offset the deleveraging that’s going on. There’s still deflation in the housing market, for example. That’s why we have much higher prices for food but reported inflation remains low.

We do have inflation rising to uncomfortable levels in the emerging nations. They’ve imported the Fed’s easy money by keeping their currencies pegged to the dollar and they have growing economies rather than deleveraging economies. General price inflation is a problem in the emerging economies, and their efforts to stem inflation have been modest and ineffective to date.

The big effect in the emerging economies is social. Food makes up a much higher portion of the household budget in emerging nations than in the developed world. It’s more difficult for those households to reduce other consumption when food prices rise. The effects of higher food prices have been destabilizing. They are considered a factor behind recent riots and changes in government. Higher food prices also are making global income inequality worse, also leading to social unrest.

“The message that goes out from Egypt to the rest of the world is that governments have to get ahead of the process,” Mohamed El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California, told Bloomberg Television’s “Surveillance Midday” with Tom Keene on Feb. 10. “There are many countries today around the world that are dealing with food inflation, that are dealing with high youth unemployment, that are dealing with income inequality.”

The test for governments is balancing the need to spur growth with demands to cut debt that surged with the financial crisis. The risk is that they resort to protectionism and currency management, while delaying budget deficit reduction, as short-term remedies. Such concerns loom over two days of talks among central bankers and finance ministers from the Group of 20 nations starting Feb 18 in Paris.

Governments will have to take serious measures to control inflation and other economic problems. These actions probably will accelerate in the last half of 2011. Those efforts will be coupled with the likely run-off of the stimulus measures in the U.S. That’s why I remain cautious about the second half of 2011. There is strong potential for reduced economic growth in the U.S. and elsewhere. We’re keeping our portfolios invested, but we remain balanced and have sell signals in place for investments that are sensitive to economic growth.