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[music] consuelo mack: this week on wealthtrack, twotop global strategists, fort washington advisors’ nick sargen and new york life’s john kimdiscuss markets at a crossroad. which direction should investors take as world economies slow,government stimulus wanes and global risks increase? nick sargen and john kim are nexton consuelo mack wealthtrack. sponsor: the company keep is also the companywe keep. together we'll provide lifetime guaranteeincome and investments solutions. sponsor: additional funding provided by:loomis-sayles - investors seeking the exceptional opportunities globally. research affiliates- efficient index foreign inefficient market.
the wintergreen fund - your home for globalvalue. rosalind p. walter hello and welcome to this edition of wealthtrack.i’m consuelo mack. “fair is foul and foul is fair†say the witches in macbeth; forall of the fair benefits of globalization, it is the foul perils that are being feltin the markets right now. the dichotomy of eurozone interdependency- one currency, butmany government policies- is turning out to be an ongoing curse for the 27 nation union,their banks and global markets. this week the fears of debt difficulties and defaultspread from greece, to italy, europe’s third largest economy, to spain, its fourth biggest,as well as the other heavily indebted countries
known as the piigs, including portugal andireland. at one point, for the first time since the euro was created in 1999, interestrates on ten year spanish and italian bonds climbed above six percent. to put that intocontext, yields on ten year bonds in germany, considered to be the strongman of europe,are yielding under three percent. as this chart from strategas research shows, the differencein yields or spreads between other european government bonds and german bonds has wideneddramatically. strategas’ conclusion: “anything that isn’t u.s., german, or perhaps japanesesovereign debt is likely to come under increased pressure.†meanwhile the u.s. is under increasing pressureto resolve its debt ceiling impass. ratings
agencies s&p and moody’s say they are reviewingthe government’s triple-a rating in light of the rising possibility that the $14.29trillion borrowing limit won’t be raised in time for the government to pay its bills.however, investors don’t seem alarmed. once again, they sought out the safety of u.s.treasury bonds. contrary to just about every wall street prognosticator, treasuries haveappreciated this year, once again giving stocks a run for their money. u.s. stocks, meanwhile,have had their share of volatility in recent weeks, but are still in positive territoryfor the year. what’s the outlook from here? we are joinedby two highly respected investment pros. john kim is chief investment officer of new yorklife, where he oversees more than $330 billion
in assets. new york life is a sponsor of wealthtrack,but john is here on his own merits. he has a 26 year track record of running investmentmanagement and retirement businesses at major insurance firms. nick sargen is chief investmentofficer of fort washington investment advisors, the investment arm of another insurance firm,western & southern. nick is a long time international economist and global money manager with experienceat several top wall street firms, as well as the federal reserve and u.s. treasury.i began the interview by asking nick why he believes the markets are at a crossroads. nick sargen: for two years now, we’ve hadthe strongest rally in the stock market, off the lows. so you doubled in value. but itwas broader than the stock market. almost
all so-called ’risk assets,’ corporatebonds, high-yield bonds, also did extremely well. so in the last couple of months, though,we’ve had markets now much more choppy. and why? that’s why i said i think we’reat an inflection point. and there’s so many things we have to consider today. questioni have: the economy, it disappointed in the first half. will it come back, as some peoplesay, in the second half, or not? inflation, some people focus on food and energyand say it’s going up, but the core rate has remained tame. so which one will be theaggregate policy? the federal reserve has completed its quantitative easing program,and what will that do? and now, of course, on the budget, we’ve gone from massive stimulusto some restraint, we don’t know how much,
and then developments abroad. you have middleeast oil prices up; japan- the tsunami, the nuclear; and then europe, the problems againresurfacing. so all of these factors you have to weigh, and many are offset. consuelo mack: all right, so there we are.so the markets have to kind of digest all of these factors. so the question is, so howdo you think the markets are going to digest them? i mean, what’s your outlook for thesecond half? nick sargen: that’s right. i begin withthe economy, because i think that was the big disappointment. and many people were gettingencouraged that finally maybe we got escape velocity, the term larry summers uses, thatmaybe growth would have been strong enough
that we start to create enough jobs so youcan back away from the stimulus programs. and then, instead, the growth rate came in,in the first half of the year, two percent, half of what was forecast. so i believe that there’s some reasons thatthings will be better. oil prices have come off their peak and that will put more moneyinto people’s pocketbooks. and we basically have also the situation where the supply disruptionswith japan are waning. auto production is being boosted. the but, though, is it is thispolicy situation that the fed is not going to do a third quantitative easing programimmediately. and then, for the first time, i’m glad fiscal restraint is coming, butit will be a drag. so my call is that the
economy will be able to do somewhat better,but we’re not going to meet the expectations at the beginning of the year. consuelo mack: all right, so somewhat betterthan the first half. nick sargen: yes. consuelo mack: so john kim, markets at a crossroad,you know, when you think of all of the things that nick has just mentioned that we’redealing with, what do you think the impact is going to be in the economy? john kim: we don’t focus a lot on the short-term,but as nick suggested, i believe that the economy will be stronger in the second half.perhaps three-and-a-half percent in the third
and fourth quarter. consuelo mack: for gdp? john kim: for gdp growth rate. clearly themonetary and fiscal stimulus, at least in the near term, will continue. and so investorswill generally have this risk-on posture. and as a result, i believe that equities andspread products in the credit markets will do generally fairly well. consuelo mack: so high-yield bonds, for instance?what about commodities? i mean, so all of the risk-on trades that you’re talking about,so the stocks and the things that people who are more aggressive investors, that they tendto, you think that those are going to continue
to do well, in the second half? john kim: i do, however, i would say thatcommodities tend to one part investments and another part related to the fundamentals ofhow the global economies are doing. i do think commodity prices, starting with oil, willremain fairly benign here for the foreseeable future, which really is the reason why theeconomy should do well, because they have come off of their highs, so it’s going tohelp the economic growth. not only in the u.s., but worldwide. clearly, high-yield bonds, i believe, willdo well. if you look at on a spread over treasuries basis, high-yield bonds are trading at theirhistorical averages. and the default environment
is so nonexistent today that just clippingcoupon in the high-yield sector will provide you with a pretty handsome total rate of return. consuelo mack: so longer term, and i knowthis is what wealthtrack focuses on, as do you two, because your respective insurancecompanies have got to meet those long-term liabilities. so longer term, john, you havesome pretty serious concerns, right? so looking to 2012 and beyond. john kim: sure, no question. longer term,there’s so many downside risks that i see versus upside potential, and that’s a causeof great concern to us. so if you start with the u.s., and then we could spend hours andtalk about the rest of the world, but just
in the u.s., we’ve got a chronic high unemploymentsituation, which i don’t believe we’re going to reduce our unemployment rate, norour underemployment rate, to a meaningful degree, in the foreseeable future. the housingsector, it’s the worst it’s ever been and this is not, in my mind, an area that’sgoing to recover very, very quickly. and then last but not least, we talk about the debtload of the federal government, but the consumer debt load is still near record highs. so youadd 14.5 trillion of the federal debt and then you add 2.4 trillion of consumer debton the aggregate. and those are numbers that are not going to get pared-down quickly inthe near-term. consuelo mack: so before i hide under a rockessentially, i’ll ask you about the investment
implications in a minute. but nick, as faras the long-term burdens that you see, i mean, and versus maybe the long-term drivers ofgrowth, how do you come out in those areas? nick sargen: you know, i agree with a numberof the points that john was making especially. i think that the unemployment rate just isn’tresponding as quickly as it did before, and i think it’s a different cycle. it’s adebt cycle, it is an inflation cycle, where once the fed eases, jobs could come back quickly.but maybe just as the counterbalance is that why is it then that i’m not overly bearish?and i think that when you go and ask the question, why did the stock market double if the economyisn’t doing all that well, i always tell people, i said, “remember, the stock marketis the barometer of the corporate sector.â€
and so what’s been amazing is that we’vebasically seen corporate profits that had gotten hammered in the financial crisis rebound,and are now above their pre-crisis levels. and then again, when we go and look at justequity market valuations, pe multiples or however you choose to do it, they don’tlook at extremes. they’re not cheap. so my feeling is we’re probably in a continuedpattern of a sub-par expansion, but it is an expansion. i think inflation is not goingto rear out of control, and therefore rates stay lower longer. and the corporate sectoris the bright spot in otherwise sectors that are in trouble, such as housing, that youmentioned. consuelo mack: so john, tell me about hownew york life is changing its risk management
approach, and also then let’s talk aboutsome of the longer-term scenarios that you’re working on, and tell us about the investmentimplications. john kim: sure, right. i might qualify thatstatement. it’s rather than changing, we’re sort of clarifying the way we look at risk.what we have done, we’ve actually been forced to do this, consuelo, is that because of ourinability to accurately predict the probability of something occurring, we’ve actually lookedat various events and not try to spend as much effort and resources on trying to determinethe probability of it, but more importantly, what’s the path of those events, if theywere to occur. and we tried to identify some leading indicators of things that we shouldbe focused in on. and at the point that those
indicators are triggered, then we’ll paygreater attention to perhaps the probability of that particular investment occurring. consuelo mack: so give us an example of aworking scenario that you’re looking at, and how you’re analyzing that. john kim: absolutely. so the euro crisis andhow the greek situation and now the portuguese situation is evolving, is capturing a lotof sort of attention and discussions and the like. who knows what the ultimate sort ofrestructuring of the greek bailout plan is going to be. in many respects i feel liketoday, we’re just kicking the can down the road here. and we have the inevitable restructuringof the entire debt structure of not only greece,
but all of the pigs economies here. so rather than try to determine what the probabilityand the makeup of a greek restructuring might look like, we might wish to focus in on anotherindicator to give us some insight as to when the inevitable is going to occur. and in theeuro situation, ultimately we’re less concerned about greece, but more concerned about spain,because spain, as opposed to greece- greece is about two percent of the european unioneconomy, spain is 12%. and so we think that just calibrating where the spanish debt rateis, it might be a better indication of how the european situation is ultimately goingto resolve itself. so that by way of example. consuelo mack: all right, and so what is ittelling you?
john kim: it’s telling us that the 10-yearspanish government bond last november was at 4%. today it’s around 5.5%, which clearlysuggests that spain is not in the news prominently, but there is some now concerns that this sortof greek and portuguese contagion effect might now impact that rest of continental europe.and so we would suggest that if the spanish government bond rises from 5.5% to perhaps7.5%, 8%, that would be a cause for alarm. consuelo mack: so nick, how alarmed are youabout what’s going on in the eurozone, and how are you reacting to it? nick sargen: so really, i think what caughtmy attention in the last month was when i realized that there were the protests in greece,and the greek government nearly fell. suddenly
what this told you is, wait a minute. is itthe creditors who are calling the shots, or is it the debtor countries? so what i simplydid, in the sense of urgency, is said okay, i don’t have the luxury of saying i’llworry about this two years from now. so we called together our little war room, and discussedhow we thought things would play out. you know, one of the big fears was, is thisanother lehman situation or not? our conclusion was no. that unlike subprime, where it wassurprise, surprise, surprise, you didn’t know this; who doesn’t know what greece’sdebt is, and who holds that, that same four. so there’s much greater transparency. andtherefore i think less risk of the contagion. but it’s funny, as john mentioned, whatwould be a game changer? and we didn’t even
talk about this, but my story has been, ifyou get spain into the equation, that becomes a game changer. why? because the size of theeconomy and the linkages in the international financial system, and if spain goes, nextup on the on-deck circle is italy. consuelo mack: when do you start, number one,reacting as investors? and if, in fact, you start to see the spanish bonds moving up,what do you do as a result? john kim: sure, right. well, two things. oneis that if you have any exposure to the european markets, then you might want to consider paringback that exposure. consuelo mack: and you’re talking aboutthe equity markets, the bond markets, right. john kim: correct. and the fixed income markets,exactly. so if you’re in a european equity
fund, for example, and you see the 10-yearspanish government bond rising, that might be a good leading indicator that there mightbe more systemic issues for continental europe. the second, though, and nick mentioned thecomment about a contagion effect here, i believe there’s a very small probability, but it’snot zero, that a collapse of the eurozone in some form or fashion led not by greeceor portugal, but by spain and italy, might have a contagion effect for the rest of theworld economies here. so the first order would be look at your portfolio in the context ofyour exposure directly to europe. but then the second would be, if there is some fearand expectation that this could have a contagion-like effect for the rest of the global markets,then you might want to take some risk off
the table for the rest of the portfolio. consuelo mack: so let me ask you about othergame changers. and nick, you just got back from china. and there is a consensus, i thinkprobably it’s a global consensus, that china is the new, the emerging world power. it’sgoing to be the driver of global growth, it’s going to pick up the slack of the u.s. sowhat’s your assessment of china, and that scenario playing out? nick sargen: and you know, it’s clear, ithas been the leading engine for over a decade now. and i would say it’s a game changer.so if something went wrong in china, where it would first show up would be other emergingasian economies that have really benefited,
plus other emerging economies including brazil,and the like, that are resource-based, shipping into china. so when i went there, i guessi was a bit surprised, the people i spoke to, unlike the united states, there’s tremendousconfidence, and i guess understandably so, they’ve grown at double digits, they gotthrough the financial crisis with not much disruption. but i would say, consuelo, still,the reports beneath the surface are a bit more troubling. we all know about the housingboom there, property boom. but more and more, the stories that we’re hearing is that thegovernment encouraged, during the weak period after the financial crisis, local governmentsand banks to make tremendous amounts of investment. now, you always say, well, how can investmentbe bad? but in china today, investments are
50% of the economy. and i don’t know anyeconomy that can sustain that high level without problems. and we’re starting to see themin servicing. so the real question then, in my mind, is okay, let’s assume that there’sa hiccup somewhere along the line, how bad will it be? i’ve come away, rightly or wrongly,with a conclusion i don’t think it will be an asian style financial crisis. becausechina has $3 trillion of foreign exchange reserves and they have capital controls. it’snot money coming in, money going out. but at the end of the day, what it will be isthat the chinese government basically underwriting the problem loans. and there won’t be congressionalhearings about whether the electorate thinks it’s a good idea.
consuelo mack: they can just do it. nick sargen: they will do it. so you couldsay, well, that’s not so bad. however, the question then is, though, in order to underwritethese bad loans, could you see their growth trajectory slow below 8%? for china, thatwould be a big deal because they need that much growth to continue the migration fromthe rural areas into the city. so that’s the type of issue that you’re tracking. consuelo mack: so below 8% is like a recessionin china? nick sargen: let’s call it a growth recession. consuelo mack: one of your major investmentconcerns, john, is the fact that you’re
concerned about it here at home, is the possibilityof stagflation. john kim: yes, right. consuelo mack: and so tell us about why youthink that that is a risk, and especially for investors. john kim: sure. so when we talk about possibilities,again, i think it’s a remote possibility, a low probability. but we are always concernedabout these outlier risks out there. so one can very easily cobble together a scenariowhere the u.s. economy remains fairly stagnant- not fall into a recession, but a flattishtype of an economic growth, very similar to, again, what nick mentioned a few minutes ago.then you’ve got the exogenous factors that
will cause inflation that will come into oursystem, that’s utterly out of our control. consuelo mack: so nick, what is a major investmentthing that you’re following at fort washington? nick sargen: the idea is pretty simple, isthat some of the bigger companies, the bigger blue chip names, have really probably underperformed,so from a valuation perspective, look attractive to us. and if we can get dividend yields thatare close to what we can get on corporate bonds, why not. consuelo mack: so john kim, major investmentthemes for you at new york life? john kim: sure. and that would be basicallygo international, don’t go all into emerging markets or developing markets. so go intoa nice high quality international fund that
invests both in developed and developing market,and importantly, the core of that investment strategy should not have any overt currencyhedging. so let the investment sort of ride the natural local currency exposure that wouldbe coming from the collection of the stocks and bonds that would be in the portfolio. consuelo mack: so it would be a diversifiedinternational fund, but with both stocks and bonds. john kim: that’s right. consuelo mack: right, unhedged. john kim: so taking advantage of opportunities,the outsized opportunities outside the u.s.,
and having non-dollar exposure. consuelo mack: so, nick, one investment fora long-term diversified portfolio. what should we all consider owning some of? nick sargen: i agree that the housing marketis not about to turn quickly. but i still believe that investors looking for a long-terminvestment, that if you ask this question, which market today is most mispriced? we saidit wasn’t the stock market, or necessarily the bond market. but i have a housing marketwhere, on average, home prices are off 35% from the peak, or more. some locales evenmore than that. but then add to that where mortgage rates are- almost as low as i canremember in my lifetime, and i’m not a young
guy. so you combine the interest rate on yourmortgage with the cheaper home price, and housing affordability is now the cheapestin four decades. but today i hear people tell me home prices will never go up. that, tome, is again, the overreaction. so have fun. go out and buy a home today. consuelo mack: good advice, especially foryounger people who are avoiding buying homes now and are becoming renters and rent prices,we know, are going up. nick sargen: right, exactly. consuelo mack: so thank you so much, bothof you, for such a terrific conversation, some great investment ideas, as well. nicksargen, from fort washington investment advisors,
and john kim from new york life, thanks forjoining us on wealthtrack. nick sargen: thank you. consuelo mack: who would have thought thatbuying a home would ever be considered a contrarian investment idea? on that note we will wrapup this edition of wealthtrack. next week we are sitting down with one of our greatinvestors. dennis stattman, who has run blackrock’s now $55 billion global allocation fund sinceits 1989 inception, will join us to talk about the opportunities he is still finding aroundthe world. in the meantime to watch this program again,please go to our website, wealthtrack.com, to see it as a podcast or streaming video.and while you are there, check out wealthtrack
extra, where you can find complete, extendedinterviews with other recent financial thought leaders and great investor guests. thank youfor visiting with us and make the week ahead a profitable and a productive one.
