5 Worries From the 2012 Morningstar Investment Conference

Attendees of the 2012 Morningstar Investment Conference seemed to be more interested in defense than offense last week. During the past few years, the chatter at the event was about where the next big thing was, or just how far the rally could go. But the big focus this year seemed to be on what could go wrong and the best way to protect assets in any environment. Here are five worries that seemed to come up over and over again during the conference.

Treasuries
If there was any agreement on any one item at the conference, it was that Treasuries are trouble right now.

Steve Walsh from Western Asset Management seemed to summarize most participants' views that Treasuries are being used as an insurance policy against bad outcomes at the moment. They aren't being treated as an investment. Money is flowing into the asset class from around the world as a safe haven to protect against a breakdown in Europe or a hard landing in the Chinese economy. Add in the Federal Reserve's massive amounts of easing and unprecedented easy money policy, and you have the recipe for an asset whose pricing has become unmoored from economic fundamentals. Accepting what will almost certainly be a negative real return during the next decade just didn't make sense to most speakers at the conference. Franklin Templeton's Michael Hasenstab might have said it best when he described Treasuries as a risk-free asset no more. 

No Good Options for Cash
A corollary to the worries about the Treasury market is that there are very few options for cash at the moment. Associate director of fund research Miriam Sjoblom quipped at the start of her panel on cash management that only a few years ago it would be unimaginable that the room would be packed for a discussion on cash. But it was packed this year because no one has any idea what to do with cash at the moment and everyone was interested in seeing if there were any way to wring out some extra yield. Unfortunately, there is no free lunch. In order to get a nonzero yield, you need to move up the risk spectrum, something investors who are trying to keep their assets safe might not find appealing.

The lack of options for cash can also have an impact on investor behavior. Even GMO's Jeremy Grantham, not exactly known for a lack of discipline, said with yields so low on cash, he has to exercise a lot of power to keep himself from considering risky assets that he doesn't think have great return potential. Now of course, the Fed pushing people into risky assets is a feature, not a bug, of its easy money policy. But for investors who are looking for a cash cushion and want to keep some powder dry for a rainy day, the current environment is very challenging.

United States
The U.S. fiscal situation was another hot topic of conversation. Almost everyone agreed that United States' financial house was far from in order, but that at the moment we are being saved by the fact the dollar remains the reserve currency and that Treasuries are seen as a safe asset. This has covered up the fact that the political system hasn't tackled long-term entitlement issues or made any progress on the looming fiscal cliff. Almost no one seemed optimistic that any of these issues were going to be solved until there was a crisis that forced politicians' hands. Panelists were worried that the fiscal situation could force higher inflation or hugely increase U.S. borrowing costs and crowd out other spending. Grantham was one of the only speakers who seemed to think that fears about U.S. debt levels were somewhat overblown.

Europe
No one was surprised that Europe wasn't far from any conversation at the conference. This seemed to be the downside scenario that is keeping most people up at night. The take on the future of Europe ranged from Loomis Sayles' Dan Fuss' worries that the continent could erupt in conflict, to University of Michigan professor Jim Adams' presentation on how the euro is indispensable and that Europe will likely reach the needed political compromise to keep the common currency mostly intact. Many also nodded at Hasenstab's view that Europe won't fall apart but that there would be a lot of pain along the way.

The one thing about Europe that everyone agreed on was that no one really has an idea of exactly what's going to happen. Given the political and economic elements inherent to the crisis, everyone who offered a prediction took special effort to stress that there is still a large amount of uncertainty regarding the eventual outcome. So when it comes to Europe, it seems like we should all continue to expect the unexpected.

China
After Europe, China seemed to be the next most cited example of a serious risk to the global economy. Almost everyone agreed that a sudden, sharp slowdown in Chinese growth (a so-called hard landing) would shock the rest of the world into recession. There was little consensus on exactly what growth in China would look like in both the short and long term. Hasenstab thought that the Chinese government can use its massive reserves ($3 trillion) to stave off any banking crisis and that it is savvy enough not to try to tighten monetary policy too quickly. In fact China's leaders are already starting to ease policy. Grantham on the other hand was less excited about China's prospects. His thoughts were that higher commodity prices will put pressure on the country's future growth. Although no one was explicitly calling for China to hit the skids immediately, the fear of that happening was clearly on many attendees' minds.