As the Morningstar Investment Conference in Chicago wrapped up two weeks ago, I was struck with how different the tone had been from the last few years. In the conference after the depths of the recession in 2009, the managers who presented were generally cautiously optimistic and excited about the prospects of respectable returns going forward. Certainly fears about the state of the economy were vocalised, but most thought we were able to get over the hump.
The change this year was palpable--to me at least. There were a lot more worries and caveats, and less confidence on where to invest today. Here are three of the most common concerns I heard voiced last week.
There Is Nothing to Buy
This is the one that had to come up the most in one form or another. The simple fact is that there aren't very many screaming opportunities in the market right now. Stocks have had a big rally, and most observers agree that by and large equities are fully valued. The fixed-income picture doesn't look any prettier. Treasury yields are almost comically low, and the prospect for returns in the sector doesn't look very good (more on that in a moment). Corporate bonds aren't providing meaningful spread over Treasuries, and when rates begin to rise, returns in that sector will get gobbled up, as well. Cash doesn't make much sense either. Rising inflation means that sitting in cash is a guaranteed real loss, not something most investors would want to consider. Although there was some consensus that high-quality, large stocks were the best value right now, they were seen by most as a least-bad option and not a great buy.
There are a few reasons why a shrinking opportunity set is worrisome. It will be very hard for investors to get the return that they need to meet their financial goals. Most people bank on being able to get a nice return (say 8%) compounded over time when they are deciding how much to save and how to plan for retirement. If the conference presenters are right, and that we should expect below-average returns from today's valuation levels, a lot of these folks are going to find themselves coming up short.
A fear of not meeting goals could lure investors into taking more risk that they should. Moving from Treasuries into high-yield corporate bonds or dividend-paying stocks or into frontier markets instead of blue-chip stocks might help juice near-term returns. But these new holdings could leave investors much more exposed to economic shocks than if they stuck with their ideal asset allocation.
This leaves investors with a difficult dilemma. Do you stick with your ideal asset allocation but potentially fall short of your goals, or do you take on more risk and leave yourself exposed to losing much more than you can afford to lose? Neither of these options is attractive and has to be a big worry for almost everyone.
Negative Real Returns on Treasuries
One asset people are particularly unhappy with is Treasuries. PIMCO manager Bill Gross kicked the conference off with his take on why the Treasuries market is in trouble. He thinks that current Treasury investors will see negative real returns 15 years from now because of the government's policy of using inflation and low rates to try and rescue the economy and keep the recovery moving. Gross thinks that Treasuries are grossly overvalued at the moment, and that's why he has eliminated them from his portfolio. That doesn't even touch on his long-term concerns about the US government's ability to bring the deficit under control.
Gross was probably the most negative on Treasuries at the conference, but there were not many managers excited about the prospects of holding US sovereign debt. Although some were more sanguine on the deficit and other structural issues, almost no one thought investors were being adequately compensated for the elevated risk in Treasuries.
The prospect of negative real returns on Treasuries is a scary one, especially for investors used to the respectable Treasury returns seen during the last few decades.
Big Banks Still Too Complicated?
One of the most intriguing discussions of the conference emerged during a panel with Will Browne of Tweedy, Browne, Ken Feinberg from Selected Funds, and David Poppe from Sequoia. All three managers agreed that they are steering clear of big banks, not because they are worried about the economy, but because large banks are still too complicated to analyse. They argued that these massive financial companies' balance sheets were black boxes and that disclosures weren't strong enough to know exactly what they held. The managers also commented that even senior management doesn't always know what the bank holds.
This is disconcerting. Even after the financial crisis and a slew of new and pending legislation, there are still many sophisticated investors who are worried about what might be lurking at big banks. Add in uncertainty about capital levels and other regulation, and these managers are steering clear of the big banks.
It should be noted that Fairholme (FAIRX) manager Bruce Berkowitz disagrees strongly with this analysis. He is much more optimistic and sees the banks, and financial-services firms in general, as buys right now, and he has heavily tilted his portfolio toward those names.
There were other many other worries expressed, from high commodity costs to tech firms squandering their large cash hoards, but these three that I mentioned above were the ones that really stood out in my mind.
What do you think? Do you agree that there aren't many opportunities in the market now? Are you steering clear of the Treasuries market? What about financials?
Bearish markets editor Bearemy Glaser is the worry-prone alter-ego of markets editor Jeremy Glaser. Each week, Bearemy will share what's topping his list of concerns and invites you to reply or add your own in the comments section below.
