Leading Asset Managers turned on the TMZ in Boston, talking about "the Fed," its Lady of the Left, and what a worldwide defaulting credit bubble means for U.S. consumers and investors.

(All asset manager quotes are from the Asset Manager Showcase, with the exception of former Fed Chairman Ben Bernanke, who was interviewed on July 28 in Boston by LPL Financial Chief Investment Officer Burt White.) 

Financial Advisor magazine held its 5th Annual Asset Manager Showcase in Boston on October 7 and 8. Top asset managers were eager to dish on Federal Reserve Chair Janet Yellen and discuss the origin and ramifications of a gargantuan global credit bubble that is beginning to let its air out.

Ben Bernanke on the Fed, Global Economics and His Legacy
"Janet was way more experienced than I was when she became the Fed [chair]," Bernanke told LPL Financial convention attendees. "You learn a lot. The world is complicated," he added. "You have to learn something about politics, psychology, markets. It's a fascinating job really." Bernanke said he wanted to make the Fed as open and transparent as possible. He praised President Obama for giving the Fed "the independence and scope it needs".

He said eight years as chairman was enough for him "just in terms of politics."

Bernanke has a sense of humor about our world problems as well: "Every day I pick up the Wall Street Journal and I say, 'All of that is a serious problem. I hope somebody does something about it, and it's certainly not going to be me.'" (Perhaps Bernanke forgets that he rode us down to zero and kept us there for five-plus years.)

In responding to his notorious 2011 quote about the problems in the subprime market being contained, Bernanke claims that the subprime market was a very small market, but that major institutions were more exposed than the Fed thought. "Investors just didn't stay away from subprime mortgages but from all securitization and all credit," he said.

Bernanke described it as "a run, a panic" that spread through all the credit markets, and he placed blame squarely on "weaknesses in risk management at these big institutions." Bernanke’s explanation begs the question: What if the Fed did not create this easy-money extravaganza in the first place. 

Many of us have heard that even Bernanke could not get a bank refinancing on his home mortgage. However, if most of us were super-rich and loans-at-less-than-inflation where available to us, we would be scooping up islands and little airports. We would not be bemoaning saving an extra 50 bps on our mortgages.

Bernanke attempted to save his reputation for the history books by insisting that it was he (and Congressional approval) alone responsible for saving AIG because they had collateral, unlike Lehman Brothers. He began to spin a story "a la TMZ." And, so it goes, Ben was having dinner with his wife, Anna, when she said, "I hate to tell you, honey, but I spent $200 on a dress today." Ben allayed Anna's fears by saying, "That's OK. Today I spent $85 billion on a rotten insurance company." As a Fed claim-to-fame story, many would argue that this bailout helped one investor of AIG! Bernanke portrayed it as his own $85 billion call that saved a globally intertwined system.

Bernanke feels that by "intervening in a very strong way" to prevent total system collapse, he saved the world from "another Great Depression." He is adamant that he saved the system and "protecting the system was very important to protecting the economy." To emphasize his point, he cites Ron Paul and says, "I don't know, have people been investing in gold? How's that working out for you?" (Perhaps if we ever returned to the gold standard, this would be a valid comparison.)

When asked by Burt White, LPL Financial chief investment officer, if QE is responsible for the greater income disparity in America, Bernanke emphatically said, "No! ... QE has almost nothing to do with that." Bernanke instead blamed globalization and said that QE and monetary policy has helped to create jobs and "helped the people in the middle." He followed that assertion with, "I'm a blogger now for Brookings Institute." (Bernanke blogged about Greece in July, about nothing in June or August, and plugged his book plug in August just before its launch.)

Regarding rising interest rates, Bernanke non-answered, "It's a tough judgment call at this point."

The closest Bernanke came to echoing an asset manager was, "Start-ups [and small business] have been trending down. Entrepreneurship has not been as good as we would like." He cited heightened regulation and lowered access to credit.

Bernanke's summer commentary proved a spot-on prelude to what is on top Asset Managers' minds this Fall.
 

David Ellison, Senior Vice President and Portfolio Manager, Hennessey Funds
Ellison said, "The people at the Fed need to just stop talking. You are not going to do these 'one-off' pre-book tours—the book they are going to write after they leave government services." Ellison called the Fed "too much TMZ for me".

"We've had 30 years to raise rates and be the good guy," said Ellison, adding that we are trapped in this situation where rates are low.

Ellison blames the Fed for taking the whole asset class of cash and making it "basically do nothing." As a result, he said, "We've taken money and made it useless. It's like saying we're going to build iPhones for 30 years and make them worthless." 

It is this monetary policy that made the "mathematics of a rate increase mathematically scary," said Ellison. "A one percent rise in rates will decline a 30-year bond issued at par 30 percent," he emphasized as if to say "30-year bonds anyone?" Ellison described a 30-year bull market in bonds, in which every time the Fed would lower rates, bond holders would sell and take their profits.

In Ellison's TMZ-world of the Fed, "you can't lose money in bonds because you have 'the maestro' in office." He said that it is now a world in which you cannot make money on "the other side" if you can't make money "on the credit side". He does see a solid opportunity in industries such as banking restructuring going forward. "M&A will be an important part of the process of restructuring." He said we have too many banks and one-third of them do not make any money because they are too vertically integrated. "But we have to have all these products because that's how we get the business," he said, mocking the banks' rationale. Perhaps the one backhanded compliment Ellison gave the Fed is that it is forcing regulation, and "the traditional banks are in pretty good shape." Due to stress tests and this imposed regulation, "they've basically been nationalized," he said.

For anyone who might take issue with Ellison's assessment of the Fed's power over banks, he says, "The Fed can say to banks, 'You can't pay a dividend.' What other industry can do that?" he asked.

Ellison poked fun at Bernanke's assertion that it's time to raise rates by saying, "It's amazing what you learn when you try to write a book."
 

Margie Patel, Managing Director and Senior Portfolio Manager for Wells Capital Management
"The Fed has put itself into an impossible box," Patel said. She cited Yellen's abruptly ending a speech at the end of September because of "dehydration." "They've been on this zero-interest rate campaign for seven years. Two percent would be normal and we're not there." She finds it ironic that people are worried about inflation when the Fed is actually "deflationary," freezing up interbank lending. "[Banks] might as well lend to the Fed and get a risk-free return from that," she said, adding that we are likely looking at this deflationary, no-growth world for a number of years.

"The Fed holds 40 percent of the Treasury debt," said Patel, calling the Fed "one of the bad actors" in a stagnant economy. As if delivering the TMZ-like zingers of the Fed being a frigid, caged, deflationary bad actor is not descriptive enough, she warned, "If the Fed doesn't normalize, it's on the path to Europe."
 

Richard Bernstein, CEO/CIO of Richard Bernstein Advisors
Bernstein said that we are in a very minor profits recession right now and that "whenever the Fed raises interest rates, it is a negative for the stock market." However, he qualified, "The positive of profits growth overwhelms the negative of rising interest rates." 

Yet another money manager not eager to sign the Fed's yearbook, Bernstein said, "The Fed is now threatening to raise rates in a time when there is very little growth in profits or when profits growth is negative." Bernstein attributes this simple concept to continuing volatility. He believes that earnings growth will rebound next year.

"It's all PR for the Fed," Bernstein said, adding that the "impossible question" that we should all be asking is, "What is the probability that the entire world becomes Japan?" He believes that the deflation of the global credit bubble has essentially turned the whole world into Japan. "In a period of credit deflation, monetary policy would be impotent," Bernstein said, noting that he thinks this will continue to be the case. Bernstein is another all-star money manager who slams the Fed for her "impotence" and feels that we have made money worthless (try to digest that thought the next time you misplace your money clip).

Adding to the backhanded compliments, Bernstein said, "The U.S. economy doesn't suck." He said that it is printing money and using it to create credit that creates inflation. He cites the point when the yield curve inverts as the telltale sign that the Fed has tightened too much.
 

Srikanth Iyer, Ignacio Sosa, Chris Remington, James Swanson and Dan Fuss
Srikanth Iyer of Guardian Capital, in a presentation with Aston Funds, focused on how to assess global dividends. Iyer was not without his firm's thoughts on the Fed. "We are in fatigue stage right now as far as Yellen goes," he said, "Waiting for her ...  is an erroneous way to manage money." He added that "the U.S. is literally the center of the world right now. The whole world depends on the U.S. to bail them out."

Ignacio Sosa, DoubleLine Capital's director of product solutions, called the International Monetary Fund's Christine Lagarde "the Fed's most vocal cheerleader." Lagarde has repeatedly warned that the Fed should not raise interest rates unless it intends to keep them raised.

Chris Remington, institutional portfolio manager for Eaton Vance Investment Management, called the U.S. "a bright spot globally" because "companies have been deleveraging over the past five years." Remington is yet another who gave the Fed some double-edged compliments by pointing out that the institution has come up with "leveraged loan guidance" for companies, with rules about non borrowing more than seven times EBITDA and guidelines for payback periods. In a capitalist society that used to thrive on private equity deals and companies being able to access and deploy cash as they see fit, leveraged loan guidance seems to some big players like Fed handcuffs.

James Swanson, chief investment strategist for MFS Investment Management, said, "The Fed is haunted by her parents in the Depression." Swanson does not believe the Fed is going to change course anytime soon. He commented that the Fed wrongly thought debt creation would stimulate the economy. "They have this mistaken notion that to raise interest rates would actually be tightening," he said.

Less the Fed go unpunched by a panelist, Dan Fuss, vice chairman of Loomis Sayles & Co, added, "The Fed is trapped; they have a domestic mandate and an international problem."
 

The "Walmart World"
A lot of the money managers' themes in Boston centered on the depth of the global credit problems and how to best clean up the mess after having a globally "open bar" and all-night party for seven years and counting.

To lend some perspective to the problems of a globally deflating credit bubble, Ellison pointed out, "The bond market is four times the size of the stock market in this country alone."

"Be careful in areas of the economy where there has been a lot of lending," he said, citing housing and commercial real estate. "We need to start the process of allowing money to have value again." He said that a lot of money has been lent, which means that companies now have to deal with that.

Citing what he sees as the biggest U.S. positive, Ellison said, "The market is a place where you price assets ... a place to dump money and also to pull money out. ... We have the most liquid market in the world."

Joshua Jones, CFA and portfolio manager for Boston Partners Global Long/Short, described China's data as "hard to analyze" because their "synthetic GDP creation" causes a "mathematical problem".

"Where there are excesses in credit creation is always where there's the largest adjustment period macro economically," said Jones. He said that in the last six months, all the money his firm has made is on the short side and that they have been covering their shorts lately.

Sosa, channeling DoubleLine’s founder Jeffrey Gundlach, said, "Our sense is that everyone is overweight credit." He said, "Everyone is long credit ... because they can't get yield anywhere else." He added, "The credit sector has gone from yields up to 10 percent down to zeroish. There's no better fuel for rising interest rates than yield."

Remington likes modest-return munis right now, as well as 12- to 18-month duration high-yield coupons.

Patel spoke of the "boom in leverage around the world," as growth is negative, and said, "We have actually had days like these in the 1940s and 1950s." She said that we are witnessing some of the highest free cash flow we have ever seen, and "if you go back to World War II and the 1950s, earnings get hit, and the stock market gets hit." She believes that China's suppressing commodity prices benefits the U.S. consumer and that we are just rebalancing versus going into recession. So, Patel stated that Wells is allocating to equities and high yield.

Patel said that the she cannot look at any area of the economy and cite vibrant growth. She believes there is a 40 percent chance that we are headed for a recession. "All recessions have been caused by inappropriate monetary activity." She added that the U.S. economy is "not a juiced-up economy like the 80s or 90s" and that the U.S. consumer is not living "high on the debt hog".

Catherine LeGrew, a member of the GMO Asset Allocation team, echoed Patel: "We are expecting stagnation for the U.S. markets over the next seven years." She said that GMO sees prices as being very expensive today. LeGrew said that by retrenching and investing only in bonds and cash, it is highly unlikely investors will keep up with inflation.

GMO's favorite stocks are emerging markets value stocks, developed markets value stocks and high-quality U.S. stocks. LeGrew is also in agreement with other fixed-income managers who suggested limited duration in bond holdings because "we may see an uptick in credit defaults over the next two years or so."

GMO is known for their slightly conservative seven-year forecasts, and she showed that her firm has charted that the only asset classes that will be positive over the next seven years are emerging markets and Treasury Inflation Protected Securities (TIPS) at 20 basis points (bps).

Accuity Capital Management's Howard Needle said, "We think certain segments of the high-yield-market are good right now," citing coupons with a 1.5-year or less duration. "The spreads over Treasuries in high yield right now generate about 650 bps." Needle says that the reality of our financial world right now is that people will continue to be on an insatiable search for yield.

Jeff Davis, CIO of LMCG Investments, referred to capitalizing on a "re-emerging market." Jeff Davis called LMCG's idea about being conservative by looking abroad in an overvalued U.S. market "radical."  Due to the U.S. premium, which he is not so certain is warranted, he views non-U.S. assets with interest.

Bernstein called the world a "Walmart world right now," meaning that everyone is undercutting their competition to try and create market share. "The global credit bubble left the world with massive overcapacity, and bubbles create capacity that's not needed once the bubble deflates," Bernstein said. 

Lisa A. Ditkowsky, CFP, is the president of Pllush Capital Management Inc. and can be reached at (847) 859-2530.