Pimco's Mohamed El-Erian says its time to worry about inflation now

Posted by: Aaron Pressman on June 26, 2008

Mohamed El-Erian, the former and current star manager at Pimco and Bill Gross’s right-hand man, has a tendency to sound more than a little Greenspan-esque. It could be from his years at the International Monetary Fund, where he rose to the number two job. Next he served as a managing director at Salomon Brothers, then joined Pimco, briefly took over Harvard University’s endowment and then came back to Pimco this year. He can be prone to the same sorts of erudite Greenspan locutions that make you think “wow, is this guy smart” followed immediately by “what did he just say?”

So it’s not so easy to summarize his message as the opening speaker at Morningstar’s annual investing conference here in Chicago. El-Erian’s speech was certainly nothing like TCW bond fund manager Jeffrey Gundlach’s last year, which to summarize my summary, amounted to: Run! Head for the hills! The subprime disaster is getting worse!

Now, that’s the conventional wisdom, obvious to all. El-Erian had to reach deeper for new insights. And reach he did. He warned of “simultaneous inconsistencies,” “sequential recapitalization,” and “just-in-time risk management.” I’m not sure I could explain any of the three.

But at heart, El-Erian sees the current crisis as accentuating much larger changes that were already in progress in the world economy.
Global economic growth has been coming less from the U.S. and other developed nations and more from the emerging economies of China, Brazil, Russia and India. And that, in turn, means that the decades-long trend of declining inflation may have come to an end as the emerging players morph from suppliers of low-cost goods for us into nations filled with consumers of their own hungry to buy cars, television sets and microwave ovens.

So one crystal clear take-way for investors from this most respected of investment managers? Worry about inflation accelerating and worry about what people like Federal Reserve chairman Ben Bernake may do to stop it. At the very least, El-Erian recommended investors be sure to stock their portfolios with a healthy combination of inflation hedges, like Treasury Inflation Protected Securities, commodities and infrastructure funds. That’s the kind of advice that even the less than erudite can follow.

p.s. For those investors trapped in auction rate preferred shares issued by Pimco funds, there wasn’t any news from El-Erian, who serves as both co-chief investment officer and co-chief executive of the firm. “We are exploring a number of possibilities,” he said in answer to several questions on the subject. Pimco isn’t willing to refinance the preferreds in a way that will hurt the value of common shareholders in the same funds, he explained. “The solutions we’ve looked at so far don’t meet the test.”

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Reader Comments

Rocky

June 28, 2008 10:27 PM

Pity the foolish investors who are still buying 30 year municipal bonds at around 5% yields. In the early 1980's, similar bonds paid over 12% In a couple of years, these long bonds could be significantly under water if market interest rates back up. Current bond yields certainly don't compensate investors enough for inflation risk.

crabpaws

June 30, 2008 06:28 PM

What are infrastructure funds?? I guess I'm less than erudite.

Aaron Pressman

July 2, 2008 09:58 AM

Most of the infrastructure funds are private pools of capital. There are also some ETFs like the iShares Infrastructure Fund (IGF) and the SPDR/FTSE Macquarie Global Infrastructure Fund (GII) which might be worth checking out.

Dean Plassaras

August 1, 2008 01:15 AM

El-Erian and PIMCO (BTW I have great respect for Bill Gross' intellect) are attempting a difficult maneuver here. Trying to maintain some balance in a rapidly changing game, they seem to advocate a mix of paper assets (bonds) and real assets (commodities). Apart from the illusion of diversity( their training dictates so), the true solution can only be found on the real asset sector with further refinements in the precise asset category(ies). To use El Erian's phraseology "when markets collide", paper will probably evaporate.

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