Photo: Consuelo Mack Wealthtrack
Two investing geniuses, Bill Miller (of Legg Mason) and Paul McCulley (formerly of PIMCO) were on Consuelo Mack Wealthtrack this weekend: They talked markets, economics, and what to do next.They’re both delightful to listen to, and at only 28 minutes, the video (which we’ve embedded below) is worth your time.
But if you don’t want to watch it, we’ve taken full notes. These aren’t exact quotes: Mostly they’re inexact quotes that get the gist of what they said.
Some themes between them:
- The framework most people have for thinking about economics is totally wrong. Whether it’s flawed “household” analogies to government spending, moralistic views of macro or assumptions that the economy is just a set of pipes that occasionally burst and overheat, people need to rethink everything.
- Both think the bond bull market is over and that it’s a great time for stocks. McCulley likes a long S&P/short 10-Year Treasy trade. Miller doesn’t see the appeal of cheap 10-year yields when you can get great stocks with growth potential and higher yields.
- McCulley was adamant that the government needs to spend more money (perhaps even lots more) to help with private sector delevering and return the economy to growth. Miller mostly seeemed to agree.
Anyway, here’s our notes.
Miller: Economics needs to totally change. It has physics envy. But like physics, there are times when the classical models don’t work. Economics is based on metaphors like plumbing (fund flows, overheating, etc.). And that’s not working well right now.
There’s a difference between thinking of the economy as a complex system, and thinking of the economy as a clanking machine that operates under a set of rules.
McCulley: A liquidity trap is when the private sector voluntarily or involuntarily chooses to delever. In this situation, interest rates go to 0%, and it still doesn’t matter because the private sector doesn’t want more debt. Right now it’s mostly individuals, not corporations. Back through most of the time, it was the Fed’s job to manage the economy. Fiscal policy was off to the side. Back then, the private sector was sensitive to changes in the price of credit. Fiscal policy was secondary in stabilizing the economy. That was wonderful until the crisis “the Minsky moment.” Suddenly the Federal Reserve is the bartender at an AA Meeting: You Keep cutting the price, but nobody’s drinking!
The hardest thing is hearing people extrapolate from the household level to the public level.
Think in terms of you’re at a ballgame: It can be rational for you stand up and get a better view. But if everyone in your section stands up to get a better view, everybody stands up, and nobody has a better view, and everyone has sore feet. A director is needed to tell anyone to sit down.
We need to have the government sector take on more debt on behalf of the people. It’s not irrational to have fiscal expansion. It’s done full-throated and without apology to get us out of the fiscal trap.
What you think of at the governmental level: What can we do to get the unemployed their three squares.
Miller: This is a good example of a complex adaptive system. You can’t reason from individual behaviour to total behaviour. If the government cuts spending, somebody’s income has to fall.
McCulley: You have to look at the government’s obligations, which are inter-generational. I think we can have a lot more debt. We should purposely increase it to increase GDP. If I can increase debt and increase GDP even more, then we’ve created Keynesian alchemy. The key issue our generation, Baby Boomers, has been promised outrageous benefits that our children’s benefits will need to pay outrageous taxes in order to fill. For our kids to deliver on the promises to our generation, they’ll have outrageously high taxes. That will have negative ramifications for growth.
Miller: I agree that more government spending *may* be necessary. But nominal GDP growth may be running 4%. It’s not great, but it’s better than it’s been. The 10-year is just 2%. We’re actually growing GDO faster than our debt burden is increasing, so debt-to-GDP is technically falling.
McCulley: The Fed can keep low interest rates across the term structure if they want to. The bond market essentially involves a yield curve: Long rates are short rates plus a risk premium. When you think of how to value a 5-year note, you think of the alternative of rolling a 3-month note every 3 months for 5 years. If the Fed keeps short term rates ultra-low, then they’re keeping medium and long term rates down. What the Fed doesn’t control nearly as much is that risk premium.
Everything Ben has told us about his understanding of liquidity traps means rates will stay low at this level.
A repeat of 1937 is not going to happen under Ben
Rates can move from 2% to 2.25% simply because the risk premium of holding long-term Treasuries
If the end of the world happens, I want to have long Treasuries, canned green peas, and small firearms.
The odds of the end of the world have come down. Therefore, Treasuries as part of your canned green-pea portfolio have lost attraction.
Shorting the 10-year note against the S&P 500: I can buy into that one.
Miller: Right now in the equity market, you can get business with higher dividend rates plus a call option on growth. Hard to see why anyone would buy a Treasury unless you’re in the Armageddon camp. I’d be more definitive than Paul: The 30-year bull market in bonds is over.
McCulley: I would agree with that. I’ve been feeling warm and fuzzy about stocks since the ECB LTRO. Basically, that was the ECB saying: Armageddon is not going to happen in Europe.
Miller: Advice: Be very mistrustful about easy metaphors between households and governments and solutions. Given where we are right now at the end of a 30-year bull market in Treasuries. Think longterm.
McCulley: I really think people should look at macroeconomics from an analytical framework rather than a moral framework. Equities are due to have their time in the sun, and Treasuries are due to have their time in the cellar. Real estate — which for our generations and for our parents generation was THE asset clasotion — is probably an asset worth looking at. The property market is SO out of favour, there probably are some good opportunities. I’m keeping my eyes more sharply focused on the property market. There is value in the notion of roofs.
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