US Videos

Dorsey to Panelists: What Keeps You Up at Night?

Pat Dorsey, CFA

Dorsey: If you had to pick one big picture issue that's kind of keeping you up at night, what is it?

Ramsey: At this point dollar weakness. It's pretty clear that we have authorities that are not very focused on the exchange value of the dollar, that the desire to avoid deflation at all costs is really what's driving Ben Bernanke. In fact, last night on 60 Minutes, he estimated that he has a 100% chance or the 100% ability to avoid deflation, which I think is, to me that's a difficult one to buy into.

So, we've actually protected ourselves, and by the way, I think in periods of moderate inflation, equities can actually be a decent hedge against the loss of purchasing power. Now, not when you get above 7% or 8% or 9% inflation, but I think at moderate levels of inflation, equities can be a reasonable hedge. We've also got a small position in physical gold in our global fund and, in fact, all of our TAA funds, as a hedge against further U.S. dollar debasement.

So, we think this cyclical bull market is intact and that it pushes higher. We've actually got a target of 1410 for the S&P for 2011. But the question becomes down the road, even if those equity prices do go up, will they retain the same purchasing power that they have had in the past. So, that would be the one big late-at-night issue for me.

Dorsey: So, in your view in the inflation/deflation punchout, inflation is the knockout one?

Ramsey: Longer term, yes. I think the thing to watch is monetary velocity. Watch the money supply. I mean at this point, all of the Fed is pumped in. It's not yet showing up in the system in terms of lending and money supply. So, I don't think there is an imminent threat, but I think looking out to 2012-2013, it is a real threat.

Dorsey: What keeps you up in night, Tom?

Forester: Several things, but I'll just pick one. I think one is really, it gets back to too much debt. The way that that plays out, you see that it's the reason that Bernanke is trying to keep things going at all costs. Because he knows that at the end of the day, whether it's real estate, whether it's mortgages going bad, whether it's banks taking write-offs on that, whether it's an overlevered consumer, he needs to keep the ball going so that the debt can be serviced. Because the debt stops being serviced, the banks are really in trouble and you go back into a late '08 early '09 scenario. So it kind of forces his hand.

You're also seeing that getting played around the globe, because basically Europe is in the same issue. The reason that the Greece got in trouble was too much debt. The reason Ireland got in trouble was too much debt. The reason that we're having trouble in Portugal and Spain is too much debt. So that's really what keeps me up because that's what's driving all the decisions.

We asked this in the office the other day: These must be normal times because the market's back up, right? Oh, yeah, yeah, yeah. Oh, okay, when was the last time that the Fed was talking about printing money? Well, jeez, I don't remember the last time. When was the last time they were talking about printing $600 billion? Well, never. So, these probably aren't exactly normal times, are they? So, that keeps me up at night.

Dorsey: Charlie?

Bobrinskoy: Combination of the fixed-income bubble and the municipal bond crash that I think is coming. I think we've got state municipalities that really, at this point, have no chance of meeting their obligations. The State of Illinois cannot meet its pension obligations, [and] California, a couple of other states. And yet the bonds trade as if they are solid credit. So, I am very worried.

My one recommendation for people watching is if you own any 10-year municipal bonds, you should think about selling them, because they're being priced as if they are AAA credits and there is just lot of risk. I think they are being priced as if people assume that the federal government is going to come in and backstop them, and that might happen, but it's not absolutely certain that it will. It's not clear the people of Texas and Nebraska are going to feel okay about bailing out the taxpayers of California and Illinois.

So, I worry a lot about what's going to happen when the musical chairs game stops, because the State of Illinois just cannot meet its current obligations.

Read Full Transcript

Dorsey: How does that affect your thinking in security selection as a bottom-up equity guy? I sympathize completely with what you're saying about fixed income as an asset class [or] long-dated munis in particular, but how does that filter into your thinking about security selection?

Bobrinskoy: Yes. Everything is always a risk/reward trade-off, and to me right now equities, in particular, high-quality equities just represent a much better risk/reward trade-off versus bonds and fixed income. So the high-quality names that we're going to talk, about something like a Johnson & Johnson or IBM give you the upside with some risk. There is no doubt there is risk, but there is still the upside that we think is not being factored in. You have to put your money somewhere. I'm not saying there is no risk in the stock market, but versus the alternatives, where the flows have been going into fixed income, the equity market just is a much more attractive place to be.

Dorsey: Doug, as an asset allocator, would you agree?

Ramsey: Yeah. I do hear what Charlie is saying in terms of the good value and the large-cap high-quality stocks. I would probably, though, emphasize quality within more of a cyclical bent, because I think, if you study what unfolded, during the great meltdown, second half of '08. Really there were two distinct phases of what I'll just call defensive stocks outperforming, I mean consumer staples, health care, utilities, many of which are high quality and pretty undervalued, but there are really two phases.

There was a flight-to-quality associated with the normal discounting of just a typical garden-variety recession, and then there was a second parabolic move into those stocks. Now, remember, they were still going down, but not nearly as rapidly as everything else. That second move...

Dorsey: ...a different kind of parabola.

Ramsey: Exactly. So really that second move and let's just say from October of '08 through March of '09, in my mind – and keep in mind, we had several days during that period where the Treasury bill yield went negative. So if there was such a flight-to-quality into Treasuries, it also embedded itself in the stock market, and to-date, we've really only unwound in defensive stocks that parabolic, that real panic associated with the fear of the Great Depression 2. So I'd just be selective. I mean I certainly agree, we do those valuation studies as well. It's just I think there is still another leg for the higher quality, but more cyclically-oriented stocks to outperform.

Forester: I wanted to just throw one thing in there, because I agree with Charlie on the muni issues and whatnot. We've really taken a look at the portfolio because we own some insurance companies, and one of the ways insurance companies make their money is by buying fixed income obviously, and a large portion of that tends to be munis.

So we've gone back into the supplemental things that they send out on quarters about their investment portfolio and whatnot, trying to take a look at what are the durations of their portfolios, what exposure do they have for this exact issue. We own Travelers and Allstate, and some of the health-care insurers, and fortunately, those tend to be shorter-term liabilities, so they tend to be shorter-term assets.

But it's something we're keeping a short leash on right now, and I know Allstate has a little bit of a life insurance portion to them, but we would be looking to lighten up on life insurers at this point, and it isn't something that we're actively looking to add more on because of that sort of a risk.

Dorsey: Yeah, I was just going to follow-up on that when you were talking about the short term exposure that an Allstate or Travelers has with the P&C and the auto portfolios. So life insurers would be an equity that's very exposed to possible defaults in muni land. Other equity groups you can think of? I mean life is certainly an area that you probably start steering away from. That was one that came first to my mind, anyways.

Forester: We've been thinking that through, lately, and it's not a direct, but it's an indirect, if you will, and it's always surprised me a little bit at how reliant some stocks are on states, for example, and even some of our companies have a lot of international exposure, so they're exposed to countries, and I hadn't quite appreciated, like in Europe, for example, with the pharmaceuticals, where because they are are a national run health program, they can dictate prices oftentimes to the Pfizers of the world and what have you, and say to them, look, we like your drugs and we want them in our system, but we're going to give you a haircut and while traditionally it's been, say, 12%, now it's going to be a 22%, and it really does trickle down to these guys. And I guess, I hadn't realized just how much pricing power a lot of the governments have and that dribbles into the states as well.

Bobrinskoy: It's an obvious one, but last year my favorite short was Ambac and this year it's MBIA, which the stock has done well, but if these states start going under, MBIA I don't think can be solvent. The stock is up big this year, because they've remained liquid but I just – when you start seeing these defaults, they are leveraged 100 to 1 in terms of their guarantees of municipalities. I just don't think they've got the capital to cover those defaults.