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Top investment minds weigh in on erratic market

May 18, 2009

In recent weeks, two of the planet's most respected investment minds have weighed in with their thoughts on the state of the world's financial affairs—Bill Gross at PIMCO in southern California and Jeremy Grantham of GMO LLC in Boston.

It is always worthwhile to examine their thoughts and the logic behind them. As investor hopes and fears continue to churn the global financial markets, we are all trying to find our way in these unprecedented times.

Bill Gross and Mohamed El Erian at PIMCO are primarily known for their expertise in the fixed-income markets. They believe the future of the global economy will be dominated by de-levering, de-globalization and re-regulating.

De-levering means that the savings rate, which had declined to near zero in the United States (United Kingdom and Japan, too) will reverse trend, contributing to slower global growth.

De-globalization has appeared with beginning signs of increased trade barriers, along with government support of companies such as banks and automakers. Re-regulation is on the way as all constituents are now questioning the ability of the markets to self-regulate. The result will be a new model of government ownership and control that moves away from the free-market model that dominated the past 25 years.

From an investment standpoint, this scenario for PIMCO means a focus on high-quality investment-grade bonds, municipals and short-maturing government bonds because they expect them to provide better risk-adjusted returns versus subdued equity returns for the time being.

Jeremy Grantham at GMO offers that, while the government's extraordinary intervention into the markets has most likely staved off free falls that could have taken the stock market to much lower levels, these actions will also serve to mute returns in the future. He does, however, believe the massive government stimulus, which is just beginning to be spent, will serve to rally the stock market into next year to levels "far in excess of anything justified by short-term or long-term economic fundamentals."

He posits that the Standard & Poor's 500 index could reach the 1,000 to 1,100 level before the end of the year, which is well beyond the 880 mark that his work pegs as fair value for the stock market.

Grantham's view of lower returns over the next seven years is based on his calculations that, over the past six months, this market never sank to the relative undervalued levels of the prior secular bear-market nadirs in 1921, 1932, 1974 and 1982.

By staving off a much deeper decline in the market, government intervention has reduced the forward returns that would have been achieved off those potential lows.

The folks at both investment firms believe one of the main drags on economic growth is the decline of U.S. wealth from $50 trillion to $30 trillion (a 40-percent drop) and the repayment of $25 trillion in debt supporting that wealth. Greater detail of their views can be found on their respective company Web sites, but it is abundantly clear that both seers expect the road ahead to be a rough one for investors to navigate.
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Skarbeck is managing partner of Indianapolisbased Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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