John Lipsky

Nick Sargen & John Lipsky Transcript 9/7/12 #911

WEALTHTRACK Transcript #911- 9/7/12

CONSUELO MACK:  This week on WEALTHTRACK, preventing financial fires before they start and avoiding them if they flare up. Former IMF leader and Financial Thought Leader John Lipsky joins global strategist Nick Sargen to discuss global hot spots, Europe, China and the U.S. next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. It has been four years since the start of the worst financial crisis in the post war era. It feels like a lifetime to me. Lehman Brothers filed for bankruptcy in September 2008, tipping the world into a systemic financial meltdown which we have been recovering from ever since. It’s helpful to step back every once and while and see how far we have come since the market lows of March 2009, when the S&P closed under 700. It has more than doubled since then, but oh what a ride it has been!

One of this week’s guests, Fort Washington Investments Nick Sargen, points out that there have been three distinct market phases since the financial crisis began. First, “the sell off” from September of ‘08 to March of ‘09 when global credit markets froze, economies fell into recession, and the Fed drove interest rates to zero. During the sell-off, the S&P lost 46%, other markets plummeted; U.S. Treasuries and gold were the only major asset classes to gain.

The second phase is what Sargen calls the rally-rebound: monetary and fiscal stimulus continued, banks stabilized, and economies started to recover. From March of ‘09 to March of 2010, the S&P skyrocketed 76%, other stock markets soared as did high yield bonds.

The third phase is what we have been living through since, what Sargen terms “choppy”, the infamous risk on/risk off market buffeted by the onset of the Greek debt crisis, which has spread to other countries and brought the viability of the entire euro-zone into question. Stock markets, especially in the U.S., have actually done better than they feel through this period and bonds, especially high yield ones, have more than held their own.

Where do we go from here? Our two guests have followed every twist and turn of the financial crisis and its aftermath, one as an investment strategist the other as a major player in global finance.

Nick Sargen is a familiar face on WEALTHTRACK. He is Chief Investment Officer of Fort Washington Investment Advisors. Nick is a long time international economist and global money manager who has had top positions at major Wall Street firms including Salomon Brothers and JP Morgan Chase. He also has a Ph.D in economics from Stanford.

Our second guest is a new face on WEALTHTRACK but is well known and highly respected among global policy and financial leaders. He is John Lipsky, Distinguished Visiting Scholar at the Johns Hopkins University School of Advanced International Studies. Late last year, John retired from the International Monetary Fund where he served throughout the financial crisis from 2006-2011. John was the IMF’s First Deputy Managing Director, and became its Acting Director when Dominique Strauss Kahn resigned in 2011. Among the senior positions John held prior to the IMF was Chief Economist and Director of Research at JP Morgan and Chief Economist at Salomon Brothers. He also has a Ph.D in economics from Stanford. Needless to say, Nick and John have known each other and worked on and off together for forty years!

I began the interview by asking John Lipsky about Fed policy and how much impact additional stimulus would have.

JOHN LIPSKY: The question is, do they have tools that could produce a big impact? Interest rates area already at zero, their interest rates, and long-term interest rates are at historic lows, so they’re talking about some kind of quantitative effort, purchasing securities, et cetera, and it’s unlikely that those, what they’re contemplating would make a large difference in the economy.

CONSUELO MACK:  Nick, the markets pay attention to every utterance from the Fed, every interpretation of what the Fed might do, so what difference do you think, whatever policy the Fed could take now, would make?

NICK SARGEN: I think I’d agree with John, very little difference to the economy and he mentioned interest rates already low, I’d add banks sitting on record excess reserves. So when they do this, they’re creating more excess reserves, so the old adage, pushing on a string. But the weird thing about markets is they clearly want the Fed to do something. Don’t just stand there, do something. You know, this has been an unusual stealth rally in the past couple of months and the only explanation I have is, again, the markets hoping that the Fed will do something. And so I think they will but at the same time, I do think it will have limited impact.

CONSUELO MACK:  So John, let me ask you about where we are as far as policy in general around the world. Policymakers have been extremely active throughout the financial crisis and through the recovery, so what’s your view of the importance of policy? What kind of ammunition do policymakers have left, whether it’s politicians or Fed and monetary policymakers?

JOHN LIPSKY: Well, first of all, on the monetary side we’re in a period of unprecedented monetary expansion. Policymakers in the principle economies are generally at zero interest rates or something very close. They’re pushing virtually as hard as they can. And I think that has been helpful for sure. Again, the question is, how much more can they do? They certainly wouldn’t want to give the impression that they’re end of their tether, but no one thinks that monetary policy is going to be decisive. At the same time, in response to the crisis, fiscal debts, budgetary debts and deficits, have built up to huge levels, unprecedented levels in the industrial economies, and there’s a recognition that we need, in the short term, some sensitive turn towards medium-term discipline and reduction in deficits, and eventually in debt burdens. This is requiring a fair amount of sensitivity on the part of authorities around the world. I’m sure we’ll talk about Europe in more detail, where the challenges are much more elemental. So markets, investors really, are looking to policymakers for their agility at a time in which the challenges are large.

CONSUELO MACK:  And how important is it, Nick, as far as investor confidence is concerned, and the direction of the market?

NICK SARGEN: Policy matters and, again, it depends where you are in the cycle.  I believe the Fed’s actions, after Lehman Brothers, was the single most important thing to stabilize the financial markets.

CONSUELO MACK:  Massive stimulus, massive easing.

NICK SARGEN: So I was in favor of quantitative easing in that initial round. I think what we’re saying is though, as the conditions now in the financial system have stabilized, then it’s at the margin, how much more difference does it make? And I think that the evidence suggests it’s not going to make a big deal of difference. But, in the short run, and I have to make investment decisions in the short run as well as long run, there’s no doubt that the market feels better that the Fed will be doing some additional action. I just think in this case that good news is now priced in, fully priced into the market, so I don’t expect it to go higher once the Fed does launch the latest initiative.

CONSUELO MACK:  Alright. John, you alluded to Europe. You’ve just spend the last six years of your life basically saving the financial world at the IMF, so- and thank you for your service- how much has it improved? When I’m looking at the integrity of the financial system, the viability of the financial system, what gives you the most confidence? What’s gotten really better?

JOHN LIPSKY: There has been big action on the official side.  If we look back to the crisis and look at the reactions, big steps have been taken- regulatory and other reforms around the world, coordinated through the financial stability board, new measures of assessment of the problems through the IMF’s financial sector assessment program, big actions. Financial institutions themselves- banks recapitalizing, improving their own operations- so a lot that’s positive has been undertaken, but there’s still a long way to go before the process of restoring the stability and full effectiveness of the financial system can be decreed to have been achieved.

CONSUELO MACK:  So what are you most concerned about going forward?

JOHN LIPSKY: In the context of the financial sector? First of all, the European banking system needs to be stabilized and fortified. The European authorities are now on the verge of agreeing some very historic steps, so-called banking union in Europe, creating what they call the European stability mechanism that is able to invest directly in bank capital, a kind of a Euro-TARP. These will be very, very big steps and are very important.

CONSUELO MACK:  So are you confident that those steps will actually occur?

JOHN LIPSKY: My impression is that the European authorities recognize the need for these very difficult but very fundamental steps and I will confident they will be undertaken. It’s not going to be like a light switch, this is going to be a process, but I’m confident we’re on the way.

CONSUELO MACK:  So Nick, how confident are you, number one, about the viability of the entire financial system, how well it’s healed?

NICK SARGEN: I think that, say in the case of the United States, when the U.S. banks were able to pass those stress tests in 2009, that was again a game changer for us. So as John was alluding, although in Europe they didn’t recapitalize their banks as they should have, and so I think that the moment of truth was really in May, June, when, would Greece be forced to exit or would they opt out? And you had the problems in the Spanish banking system. And so everybody was worried, if there’s a run on the Greek banks, does it spill over to Spain and Italy, and those are much bigger players.

CONSUELO MACK:  And it seemed it definitely had.

NICK SARGEN: That was the fear. And I believe that, as John was alluding, that the European Summit then said, okay, this is the moment of truth, and they did announce some measures that will recapitalize the banking system and that will give more authority, we believe, to the European Central Bank in monitoring these developments.

CONSUELO MACK:  So they’ll become like the Fed and the Treasury, they’ll be able to directly help banks instead of having to go through the various governments.

NICK SARGEN: Exactly. So if you like, how does that affect me as an investor? Because as we’re saying who knows how it will play out? I’m less concerned about Lehman Two happening in Europe. That was a fear that we could see the unraveling of Europe’s financial system. So I think that risk has diminished. The but is… I tell people, but we’re not completely out of the woods in the sense that we’re still going to face challenges and you’ve talked about the choppy markets, well, right now people are feeling a little bit better, but I say, you know what? I think there are still to be further tests ahead, so I don’t want to get carried away and too optimistic we’ve solved Europe’s problems.

CONSUELO MACK:  Because it seems as if there is an emergency du jour, and you said that there are moments of crisis, but it strikes me that Greece is an ongoing crisis. So, John, I mean, what are the chances of Greece exiting the Eurozone and it doesn’t matter? Or the Euro?

JOHN LIPSKY: First, we need to keep it in perspective. Greece is about two percent or less than two percent of the GDP of the Eurozone. Obviously, you have to solve the situation of Greece one way or another. But the decisive issue is, first, to stabilize the financial system, to strengthen the financial system, and to create the governance mechanisms going forward, like a European banking union, like central European institutions that can deal with these kind of problems in the future, that will give confidence, not that everything’s been solved by a decision at a summit on one day, but that a process and a commitment, well, backed by a political commitment, to deal with the underlying issues in a convincing way, is what’s important.

CONSUELO MACK:  And you think that’s happening?

JOHN LIPSKY: So far. Every time we’ve come up to these kind of crises, the decisions have been taken to keep moving in a forward way, and the latest set of decisions, if they’re implemented as described, would be very, very important.

CONSUELO MACK:  All right, so these incremental steps, but it’s going in the right direction. So Nick, your job at Fort Washington is to advise clients, is how to invest no matter what happens out there. So what are you telling them? What’s your strategy advice to them?

NICK SARGEN: Well, we’re doing two things differently than what we had done previously. I think number one is, be more eager to take profits when we see outsize gains. So if we didn’t expect… say this year, you know, the market’s up digital digit. I didn’t expect to see this. Hey, I don’t have to eliminate all positions, but let’s take some profits and if I’m correct, and the market retraces, I can reinstate that. So we’re doing a little bit more trading activity than in a clear trending market. You know, the second thing is strategies in the stock market. I’ll use the example: we predominately, at Fort Washington, a value-based investor, we do have some growth portfolios. But heretofore, up to two years ago, we didn’t have a dedicated dividend portfolio strategy, and we said record low interest rates, people want stability and…

CONSUELO MACK:  And income.

NICK SARGEN: And income. So we created, for our parent, a dividend portfolio to complement our value strategies. So what that’s basically saying is there will be periods where the dividend portfolio will outperform, as it has, but there may be periods where if people say, you know, we’re passed the worst, these value or cheaper stocks will do better. So we’re combining it rather than saying put all your eggs in one style.

CONSUELO MACK:  So, John, let me ask you one more question about the Eurozone and that is, again, it’s moving markets in a daily basis. It seems to be this stop-start. I know it’s very complicated. There are 17 countries involved, 17 different governments, governments change, but do you feel that the Eurozone is basically it’s economically, it will start growing again, that in fact that the will get their act together, that it’s possible to have a political and fiscal and monetary union? Is this really realistic?

JOHN LIPSKY: Consuelo, that’s a very simple question and lends itself to a very quick answer. I’m an optimist about the medium-term outlook in Europe and about the commitment and recognition of both European governments and European citizens, about the need to continue to construct ineffective, efficient European scale economy.

CONSUELO MACK:  Why? Why do you think that the man on the street, for instance, buys into this union?

JOHN LIPSKY: The recognition that Europe, in essence, today is, on its own, or each country on its own, is relatively small and relatively isolated and in a world dominated by growing large scale markets, that they need to achieve the efficiencies and effectiveness that the United States appears to have; growing powers like China and elsewhere are developing, and they need for their own purposes, to create this European economy. There are many roads to it, but they’ve chosen a road, not an easy one, and I think they will carry it through.

Now, for in the short run, we can see that the European economy is basically in recession and there’s a little optimism that that… although it’s generally felt that the policies are put in place will produce some growth in the next few years, no one is really looking for strong growth in the Eurozone. So here, I think from an investor point of view, the question is really, will they avoid creating damage to the rest of the world economy? Could there be some instability through a breakup of the zone or things like this that investors worry about, that could have spillover effects and destabilizing effects elsewhere. So…

CONSUELO MACK:  Those are great questions. So answer them.

JOHN LIPSKY: I think I’ve given my answer, but hopefully it’s clear. This will not be solved instantly. There’s not going to be… not going to be able to wake up one morning and say, “Oh, I’m glad that’s over.” But it strikes me that you can have medium term confidence that they are going to continue to do the right things that will preserve the stability and ultimately produce an effective European economy, and stable European markets.

CONSUELO MACK:  So we better get used to, though, this uncertainty. And that means volatility in the markets. As far as what are the other hotspots? I mean China, a lot of people are saying that China, is it hard landing, is it soft landing? What do you think it’s going to be and how important is that for us as investors?

NICK SARGEN: Well, Consuelo, I did some research on that, you know, I’m continually monitoring it, but my tentative conclusions are- what I know so far, in terms of the data that have been reported- is I’m feeling better that this isn’t the bursting of the bubble that, let’s say growth goes from 10% down to four or five. There’s a Barron’s article recently, a question, I think probably seven percent or so, and somebody says, well that looks very good, but that is a deceleration.

CONSUELO MACK:  It sure is.

NICK SARGEN: So we’re feeling the effect. Where I’m coming out though, and this is the longer term call, I followed Japan when it was at double digits in the 1970s, and then at some point it began to down shift to more sustainable pace. So my expectation is, in China, we’re starting to see the beginning of that down shift from double digit to seven to eight percent. It’s not the end of the world, in fact Chinese policymakers probably say, you know, that makes sense to them.

CONSUELO MACK:  So that’s more of a softer deceleration than…

NICK SARGEN: That’s right. There will be ramifications. China’s been a major driver in the commodity markets, and that’s why we’ve seen this volatility in commodities. I’m in the camp of there is a definite slowdown. I think it will be an ongoing, a development, but I don’t believe that I’m going to be seeing an immediate bursting of the Chinese bubble at this time, and that gives me some confidence that the markets aren’t going to really swoon on us.

CONSUELO MACK:  John? China?

JOHN LIPSKY: Let me add just a word on China. Last year, the Chinese authorities promulgated their 12th five-year plan and if you read through that five-year plan, I think most investors would find that very congenial, a series of liberalizations, of refocusing the economy on the domestic markets, boosting domestic demand, especially consumer demand, creating social safety nets, strengthening the financial system, on and on, I think you’d read down that list and say yes, yes, yes, yes, yes.

The question is, will it get done? Because when you look at the 11th five year plan, you can see many of the elements were contained there that were not carried through, but there’s a major change of government coming in the next few months, so the question, consequence in China, there’s a plan that I think, most everyone thinks, is an excellent plan.  Will the authorities be able to implement that plan in a convincing way? If it will, I think we’re all convinced that China will be a strong and increasingly reliable source of strength for the global economy, not instability. So the next year will be very important and very interesting to see which way is China going.

CONSUELO MACK:  End of every WEALTHTRACK we ask our guests, One Investment for a long-term diversified portfolio. You come from a value shop at Fort Washington, Nick Sargen, so what would it be?

NICK SARGEN:  I’ll stick my neck out a little bit. It might be an early call, but I do believe it’s… we’ve done our homework, we’ve begun to make some forays into the European markets, mainly in the safer sectors- not financials- maybe telecom space and the like. So I do believe, what I’m basically saying is this could be a mega trend, but I want… I’m going to listen to John Lipsky, if he grows more confident that we’ve turned the corner, I’d be adding to positions in high quality European names at this time.

CONSUELO MACK:  And John, you don’t give investment advice.

JOHN LIPSKY: No.

CONSUELO MACK:  Nonetheless, one thing that you told me is that, basically, don’t sell the U.S. short. Why are you optimistic about the US?

JOHN LIPSKY: I am optimistic about the outlook for the U.S. economy for a number of reasons. For one, not sure that everyone has taken on board the implications of the change in the energy market in the U.S., not just a supply of cheap natural gas relative to the rest of the world, but also the increase in the production of petroleum here in the United States.

Secondly, the U.S., if we look at why a thing so sluggish… frankly, corporate spending on plant equipment has been relatively strong reflecting good profitability, good productivity gains. And so there’s no reason to think that that’s a source of problem. Corporations are very cash rich. But the housing sector, where new unit construction is far below what you think of as trend household formation rates; when you look at autos, the current sales rate means that the average age of the auto stock is still going up, you think well there’s room for improvement just in, let’s call it a kind of organic sense if people regain their confidence about the outlook. Add to that the possibility, it’s very common to say, oh, gridlock in Washington, they’re not getting anything done, think of the possibility that actually, that they will take steps after the election, that will give more confidence that things are headed in a positive direction, once again, not to solve everything at once, but they don’t have to solve everything at once. Put those all together and you have a set of– oh, and not forget the financial sector in the U.S., that has really taken a lot of steps to recapitalize and stabilize. You put those all together and you end up with a fairly favorable, I think, relatively favorable outlook for the U.S., it could be quite favorable.

CONSUELO MACK:  I feel so much better having talked to both of you, I cannot begin to tell you, as I’m sure our viewers will as well. So John Lipsky, what a treat to have you on WEALTHTRACK. I hope you’ll come back again.

JOHN LIPSKY: Thanks very much.

CONSUELO MACK:  We love talking to you, and with your very good friend, Nick Sargen from Fort Washington Investment Advisors. Thanks so much to both of you for being on WEALTHTRACK.

NICK SARGEN: Thanks.

CONSUELO MACK:  Incidentally, we will have an extended one on one interview with John Lipsky about the financial crisis and the Eurozone on our website, wealthtrack.com, starting this weekend. This week’s Action Point picks up on our guests’ guardedly optimistic views on Europe and  follows investment legend Sir John Templeton’s advice to ”buy at points of maximum pessimism.” Investment attitudes toward European stocks veer between pessimism and despair these days so this week’s Action Point is: consider high quality European stocks. One of Morningstar’s favorite European stock mutual funds is Mutual European, which has been run by WEALTHTRACK guest Philippe Brugere-Trelat since 2004 and has an outstanding track record.

Next week, we tackle the topic of the lack of investor confidence and trust in the markets with Morgan Stanley’s Chief Investment Strategist David Darst. If you would like to watch our extended interview with John Lipsky or our other guests, please go to our website, wealthtrack.com. It will be available as a WEALTHTRACK EXTRA. Thank you for watching!  Have a great weekend and make the week ahead a profitable and a productive one.