Inflation and Banking & Finance and Investing and Investment Advisers

Top local money managers hedge against stagflation

November 21, 2009

Over the years, John Cooke has learned a thing or two about making money in an uncertain economy—even one marked by rising inflation and sluggish growth. During the reign of stagflation in the ’70s and early ’80s, the investment manager turned to the new approach of dividing portfolios among knowledgeable specialists.

Today, faced with the potential for another bout with stagflation, the 70-year-old is falling back on several principles he’s honed, because he doubts markets will recapture their pre-recessionary highs for a long time.

“The future ain’t what it used to be,” said Cooke, who leads locally based Cooke Financial Group of Wells Fargo & Co., which manages $1 billion for wealthy individuals. “That’s exactly where we are today.”

Older investment managers are banking on their experiences and younger counterparts are dusting off history books. They’re all scrambling to decide how to face a future when markets may again be thrown into turmoil by the two-headed monster of frisky price increases and crummy economic conditions.

The concern seems misplaced, even laughable, at a time when the Federal Reserve Bank has slashed interest rates in the hope of stimulating the economy and preventing deflation—the downward spiral of prices that can become self-fulfilling when consumers begin to think they can delay purchases and enjoy even lower prices.

However, many investors and economists are nearly as concerned that the surge of federal money into shaky banks and the economy as a whole eventually will cause inflation to soar.

That’s the scenario envisioned by Cooke, whose organization has been named by Barron’s magazine as one of the top 100 financial advisory groups in the United States for each of the last five years.

Cooke remembers the stagflation era well. After serving as an Air Force pilot in Vietnam, he landed as a broker with New York-based Thomson McKinnon Inc. in 1969.

The middle of a deep recession was a tough time to get started as an investment adviser. Cooke spent most of his days on the road, visiting wealthy clients. Because gains were so hard to come by, he was among the first in his business to try a portfolio approach, subletting money management to specialists.

Cooke’s group still follows that approach, using 220 industry experts. Some focus on alternative energy, for example. Others concentrate on emerging companies or commodities. But they all have one thing in common: They’re well-versed in their categories.

“If I want the best international manager, it isn’t me. I don’t know companies in China or Brazil,” Cooke said. “But there are managers that do.”

Cooke expects interest rates to inevitably rise as a result of the federal government’s response to last year’s economic crisis. Today’s market conditions have distinct similarities to the sluggish circumstances when he began his career, he said. And just like in the early ’70s, he expects it to be a long time before the market recaptures its pre-recessionary highs.

For the last year, Cooke’s group has been overweighting energy stocks because it expects prices of natural gas, coal and oil to trend higher as emerging nations like China and India devour more resources. Cooke also has favored large-cap companies with strong balance sheets, especially if they’re outside the health and pharmaceutical sectors.

“You pick up rules over your lifetime,” Cooke said. “One is … don’t fight the Fed, don’t fight the trend and avoid the crowds at extremes. Crowds are going to the bond side now … which leads me to say maybe we avoid that crowd.

“That’s the kind of gray-hair experience you get over the years.”

Risk—and opportunity

William Craig Dobbs, 45, who manages $10 billion in pension fund money locally for Morgan Stanley Smith Barney’s Greystone Consulting group, isn’t expecting inflation to be a near-term issue. But in the long run, he said, the federal government’s economic stimulus and monetary policy could spur it.

One 1970s parallel Dobbs is watching closely is the sheer amount of uncertainty, which creates both risk and opportunity.

“In this environment, you need to team up with a money manager with good history going back 15 to 20 years,” he said. “Ask how well do they do in these types of markets and protect me on the downside. That’s what we have to watch for.”

After enduring a tough recession and then stagflation in the 1970s, it took investors and businesses of that era a long time to regain their confidence. Given last year’s losses, Dobbs expects a similarly slow redemption of resolve.

“You’ll see a lot more people being cautious about the way they’re doing business, rather than refinancing their house, running credit cards up and then repeating again the same cycle,” he said. “I think those days are over.”

Dodging ‘worst outcomes’

It’s impossible to say whether business and investors will face stagflation again. Tom Buck, who manages $1 billion locally for Merrill Lynch through the Buck Group, said the United States might endure slow growth and high inflation again in the next few years.

It’s also possible the economy will simply suffer a prolonged traditional recession, or that a recovery will come.

How to plan for those dramatically different scenarios depends greatly on who you are, noted Buck, 55. The person wanting to make a down payment on a house tomorrow has different financial needs than somebody looking to pay for a child’s college education in 17 years, or someone hoping to retire in five.

Whatever the scenario, Buck expects American consumer demand to be driven by needs, not wants, so he’s skeptical about sales of luxury goods and services. Like Cooke, he expects emerging nations to use more natural resources, which could drive prices higher.

“Given what we’ve just gone through, this unprecedented economic crisis, collapse, whatever noun you want to apply, I don’t believe it makes any sense at all to make an assumption there’s one economic outcome,” Buck said. “There are several. So it’s important first and foremost, to build your portfolio to defend yourself against the worst outcomes.”•

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