Editor's Note: As chairman of Credit Suisse's global equity strategy group, Steven Bleiberg believes in taking an active approach to global asset allocations. While he supports a long-term strategy of diversification, he's not shy about changing weightings as he sees opportunities around the world. Bleiberg's quarterly "Asset Allocation Perspectives" can be found on Credit Suisse's Web site, https://extra.csam.com, and in the Due Diligence Center at Morningstar's site for financial advisors, www.morningstaradvisor.com. MorningstarAdvisor Senior Editor Mimi Lord interviewed Bleiberg recently for an update on his outlook for global markets.
Lord: In April of this year, you increased equities in your global balanced portfolio to an overweighted position after being underweight for more than a year. What's causing the increased optimism?
Bleiberg: This is a tough period in the market cycle when it's hard for people to be bullish about equities in general. Every day, there's discouraging economic data and disappointing earnings announcements, and there are months and months of bad news still ahead. But we're starting to get some signs that there's light at the end of the tunnel. One of these signs is the decline in G7 short-term interest rates, which is a leading indicator of global industrial production. The catalyst for our optimism is related to the liquidity that is flowing back into the global system, which will help ignite an overall economic pickup.
Lord: Within your global equity allocations, you've made some pretty big shifts since the end of 2000, including an increase in your Japanese allocation from 5% to about 20%. Is economic reform in Japan really going to happen?
Bleiberg: Our growing optimism about Japan is a function of two things. One was the Bank of Japan's announcement in March that it was going to start targeting monetary reserves rather than interest rates. This means that they plan to pump a lot of liquidity into the system. This liquidity will either find its way into the real economy, which would be good for stocks, or if not, it likely will make its way into the financial markets, which would still be good for stocks. So we're in a very unique situation where you can make a case for Japanese equities without even being bullish on the Japanese economy. Our second reason for hope is based on the election of (Junichiro) Koizumi as the new Prime Minister. He appears to be somewhat of a new phenomenon in Japanese politics in that he has tremendous public support that may help him go beyond the factional infighting within the LDP (Liberal Democratic Party). Soon after taking office, Koizumi set up a public Web site and started a weekly e-mail to keep the public informed of his plans. A million people signed up right away for the e-mail.
Lord: What do you think of the proposals Koizumi outlined toward the end of June?
Bleiberg: There are several important components, none of which is a big surprise, since he has been on record for quite awhile in support of more aggressive write-downs of bad bank loans and of privatizing the postal-savings service. He's suggesting a plan somewhat similar to the Resolution Trust Corp. (RTC) that was used in the U.S. a decade ago to deal with the nonperforming debts of the savings and loan industry. Basically, the RTC shut down the S&Ls with the highest levels of nonperforming debt and auctioned off the collateral for whatever they could get. The good loans were essentially handed over to the big, strong banks on a silver platter, and that was the end of the story. Employment in the industry shrank considerably, the number of banks shrank considerably, and we moved on. In Japan, however, they still seem to be hesitating to use public money to buy up the bad debt.
Lord: Why hasn't Japan moved more decisively in this direction before?
Bleiberg: Japan has always tried to avoid the pain of forcing nonpaying borrowers into bankruptcy and causing lots of people to lose their jobs. So they've allowed this situation to fester for 10 years. The question is whether Koizumi can get his proposals through the Diet because there are various other factions within the LDP that are not necessarily in favor of this. A lot of the companies that would be shut down are in the construction industry, and that has traditionally been a stronghold of support for the LDP. The election in the Upper House on July 29 will be extremely important because it will determine to some extent how successful he will be in getting some of these proposals enacted.
Lord: What benefits would result from privatizing the postal-savings system?
Bleiberg: The main benefit would be that of letting the private sector have more say in how that money is invested. Currently, people go into government-run post offices to open their savings accounts, and this money is predominantly invested in Japanese government bonds. This has allowed the government to spend enormous amounts on public works and run up the deficit to 8% to 9% of GDP. By privatizing the postal-savings system, the money would be taken out of the hands of the government and hopefully be invested in more productive endeavors.
Lord: What other types of reform could help?
Bleiberg: One thing that's being considered is reducing the amount of cross shareholding. Somewhere close to 40% of Japan's stock shares is held by other companies. This is how business has been done in Japan. If you wanted someone to be a customer of yours, you went out and bought some of their stock. Now, a lot of companies are coming under pressure to use their capital more efficiently, but there can be tremendous tax implications and pricing pressure from unloading these shares too quickly. One option would be for the government to buy stock from companies wanting to reduce their cross shareholdings. In order to avoid depressing the stock, the government would need to hold the shares for a while before gradually selling them in the market.
Lord: Let's switch to your views on Europe, where you have reduced your allocation from about 30% at the end of 2000 to about 13% currently. What's going on?
Bleiberg: We basically think that continental Europe will not live up to investors' expectations that it could escape the global slowdown. One reason that we've become less optimistic is because the ECB (European Central Bank) is trapped in a dilemma of its own making. The mistake they made was to publicly state their target of 2% for inflation. The ECB set their target at the start of 1999, when commodity prices were low and inflation in many parts of the world was under 1%. At that time, keeping inflation at or below 2% didn't seem like such a tough mandate. But the boom in 1999 and early 2000 caused overall prices to rise, and the ECB now finds its hands tied. They need to cut rates to stimulate growth, but they can't really cut rates too aggressively with inflation at 3%, since they said they were targeting 2%. Contrast that with the Bank of England, which has a much more flexible mandate to target inflation at around 2.5% but with a range of 1.5% to 3.5%. And look at the U.S., where the Fed has been cutting rates aggressively since the first of the year, and it doesn't appear as if they're finished yet. This kind of monetary stimulus will help the U.S. get out of its slump a lot faster than continental Europe will be able to recover.
Lord: But don't you think that the European Monetary Union will be helpful over the long term?
Bleiberg: It's an untested situation to have a group of countries all commit to one monetary policy while still maintaining individual control over fiscal policies. One of two things has to happen. Either they move closer and closer together on a political basis until they reach one fiscal policy, or they move back in the other direction until things break apart.
Lord: What is keeping the euro from strengthening?
Bleiberg: Part of the problem is that there's a widespread perception that growth and productivity in Europe are structurally lower than they are in the U.S. If that is true, it probably has a lot to do with regulations and how European governments tend to interfere with businesses' ability to use labor effectively. There were some implicit promises with the creation of the euro that governments would make their labor markets more flexible. I would say that it's become clear in recent months that there's serious backsliding going on. Danone, the French food conglomerate, wanted to close some unprofitable cookie-manufacturing facilities, and a number of French mayors reacted by saying they would stop the sale of Danone products wherever possible. To me, that demonstrates to a troubling extent the mindset of government in a lot of European countries. Also, there have been some recent instances of indexing wages to inflation, which is not a good way to keep inflation under control.
Lord: Is it common for you to make such sizable shifts in your global allocations over a fairly short period?
Bleiberg: We don't believe in the concept of developing an asset allocation that remains static for long periods of time. Trying to take advantage of opportunities along the way is how we add value. And we don't get it right every time by any means. But this is the type of business where if you're right 55% of the time, you've got a great track record.
Lord: What are some examples of allocation bets that did and did not work out?
Bleiberg: We'll start with one that worked. In 1997, we did a good job of anticipating the problems in Asia and the impact they would have on the rest of the world. We reduced our exposure to emerging Asian markets down to almost nothing by midyear 1997. And since we were worried about Japan's exposure to the collapse in Asian currencies, we brought our Japanese allocation down to about 5% by late 1997. So from a relative standpoint, our performance was very strong in 1997. On the other hand, we had way too much money invested in Latin America back in 1994 and got hit badly when the peso devalued and Brazil got into trouble. More recently, we made a mistake last year when we went into emerging markets too early and had to retreat out of our position. We thought that emerging markets looked very cheap, but we've learned that cheapness by itself is never enough when you're investing in emerging markets. You definitely need a catalyst besides value in emerging markets.
Lord: Was that the main reason for your international growth fund's underperformance last year?
Bleiberg: No, the problem had very little to do with asset allocation, but rather with the stock selections. We overstayed our welcome in certain telecom and technology stocks in Europe and Japan.
Lord: What's the catalyst that's prompted you to build your position back to 5% in emerging markets when your MSCI World benchmark has a zero weighting there?
Bleiberg: As a group, emerging markets tend to be a leading indicator of what's going on in the rest of the world. We think that liquidity growth is going to work and that it will be reflected very quickly in emerging markets. This is not surprising, since they supply a lot of the raw materials, intermediate goods and even finished goods to developed countries. Our approach is to look at emerging markets as a whole and to set an allocation target. Then, we spread our investment over several markets, including Mexico, Korea, Taiwan, South Africa and some of the other relatively liquid markets in that universe.
Lord: Looking at the big picture, how do you respond to some people's view that slowing population growth in developed countries is going to result in much slower long-term growth?
Bleiberg: Growth is not just a function of population growth-it's also a function of productivity growth. Gains in productivity are capable of more than compensating for slower population growth. There's a correlation between higher standards of living and lower population growth-we don't need as many kids to work on the farms or in the manufacturing plants. I'm a great believer in the ingenuity of mankind. People used to think that we would be in big trouble when we ran out of whale oil. And in the 1970s, the Club of Rome was saying growth would slow because we were running out of natural resources. But the human brain is amazingly creative in coming up with ways of using substances in productive ways, and, in my view, the notion that we're running out of resources is totally unfounded. I don't mean to sound Pollyannish, but I really believe that if you give people a fair amount of political and economic freedom, their standards of living just keep getting better and better.
Lord: It would be hard to end on a happier note than that. Thanks, Steve.