Blogging the opening Keynote presentation at Morningstar's Investment Conference 2012.
Morningstar CEO Joe Mansueto takes the stage. "Welcome to the Chicago heat..." It's about 93 degrees outside. He points out that this year attendance is at record levels: 1850 participants here.
Mansueto points out that "actively-managed funds have had a challenging year..." with consistent outlows from these funds over the past 13 months. Investors are flocking to passive strategies and fixed income funds.
"Are active managers worth the fees?" he asks. "The best ones are, but that's for you to judge."
Introduces the keynote speaker, Michael Hasenstab, manager par excellence for Franklin Templeton Global Bond fund.
Should we panic?
Hasenstab's theme for his keynote address, which will no doubt be a theme of much conversation at the confernce: "Should we panic? Or are we just getting scared by the headlines?"
He sees two "panic worthy' scenarios: The Eurozone splitting apart, or an economic hard landing in China. He calls these "global game changers." "If you think they are going to happen, go buy some shotguns and canned food. It will make the Lehmann crisis look like a warm up." Fairly clear he doesn't think these outcomes are likely.
Yet the challenges will bring sustained volatility. Start with Greece and it's downward-spiral debt trap. "It would take a miracle for them to get out of this without some severe policy actions." Some scenarios: A Euro subsidy. A Greek exit from the union, which would be painful for Greece - high inflation, high unemployment. If Greece left the Eurozone, "the pain that Greece feels now under an austerity regime would be nothing."
But would a disorderly exit from the Eurozone be a tidal wave that would bring down the rest of the world? To measure that risk, look at Italy and Spain...
For Spain, things may not be as bad as they seem, Hasenstab suggests. This latest plan of capitalization is overdue, but welcome. They'll get extrnal auditors, take the pain and move on. The other thing that is important there are the fiscal reforms. For instance, the Spanish government has gained the ability to control the regional fiscal issues, which will put them on a more appropriate fiscal path. Spain is also undergoing some pretty significant labor market reforms, for the positive, he says. All good signs.
Italy is different. There, it is neccessary to push through labor reforms. "Italy has one of the most rigid and inefficient labor laws...if you hire over 14 people you can't fire anyone. So there are a lot of companies with just 14 people." It's not an efficient way to run a private sector.
But there are signs of hope: A technocratic government that's come into power because of the crisis. And there is a tenous but working relationship between that government and the politicians who will want to take credit for reforms if they work. Italy has been running prudent policies keeping their debt level even.
So he is optimistic about the future of the European Union. "What's happening in Italy and Spain, on the margins, is positive." The situation continues to be volatile but at the end of the day hard to see it completing breaking apart. In addition, something misunderstood here in the U.S. It would be extremely painful for Germany's economy to see the union split up. "So while it's painful to subsidize Greece, it's more painful to leave the union."
When we look at Europe, the real story is future health care liabilities. Looking at net present value of future health care, it tops 200% of GDP in the U.S. and of which we are doing nothing.
"Do you really want to buy treasuries paying 1.5% at 100% debt to GDP, with a future liability of 200% debt to GDP?"
Hasenstab says they are very cautious of U.S. Treasuries and in fact have no U.S. Treasury assets. Ironic, as it is the one asset considered the "safe haven." "So one of the biggest risks out there might be the one you clung to. We really need to think about how to minimize risk there."
China - a hard landing?
For there to be a hard landing in China, you'd need a major policy error, where they overtighten fiscal policy. But the opposite is happening. They are beginning to loosen up. They have done a reasonable job of managing an appropriate policy mix.
The other risk is a banking crisis. When you have $3 trillion in reserves, that's a pretty big insurance policy against a banking problem. They have a fair amoung of control and the resources to deal with non-performing loans. With gov debt to GDP 40%...the hard landing scenario is unlikely in the near term.
So no Euro explosion and no hard landing for China. "That's the anchor of our conviction and why we aren't panicing."
The bigger long term issue as Hasenstab sees it is the printing of money. There are costs. Inflation, currency debasement. You don't feel them right away but eventually you ahve to pay the price.
"Never in the history of central banks have we had such coordinated printing of money. But when you print money, not all of it stays in the country. Look at Japan. The prinitg of money in Japan was part of the fuel that created the Asian bubble. You now have the same thing times four." So over the next five years in emerging markets the risk is not a credit crunch leading to deleveraging. The bigger risk will be excessive amounts of credit coming out of the develped world. The floodgates will open, pushing assets up into possible bubble territory.
The other consequence is debasing our currency and asset price distortion. "The upward pressure on commodity prices has been the prime consequence of quantitiative easing," he says. And that pain will be felt in emerging markets. That will cause demands for wage increases and an overheating economy.
Where does this lead for opportunities?
One area he likes is southeast Asia. Some of the countries that were the biggest credit risks are now have the best credit profiles. Indonesia among most emerging markets since the late nineties have taken prudent steps to reduce debt. Debt to gdp in emerging markets is around 40%; in the developed world it is 100%. That upends what traditional risk models would say. The credit risk is in the developed world.