Pimco CEO Mohamed El-Erian says that by pushing interest rates to very low levels, central banks are pushing investors out the risk spectrum.
"Every year has elements of unpredictability, but what's in play in 2012 goes far beyond the usual risk of policy slippages, unexpected election outcomes and geopolitical hotspots," El-Erian writes in The Wall Street Journal.
Such unpredictability speaks to an uncomfortable possibility of extreme events, El-Erian warns. "'Fat tails’ — the technical term for the extremes of an outcome distribution — are risks for any global system that loses its anchors,” he says. “Economies and markets function differently, companies and households feel unsettled, and policy measures become less effective.”
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"In such a world, prudence is the name of the game, and patience will likely be rewarded," El-Erian says. "To paraphrase Will Rogers, investors are well-advised to worry first about the return of their capital and second about the return on their capital."
In doing so, El-Erian advises, they should exploit the flexibility that comes with cash and make prudent allocations to instruments that pay positive real returns, including high-quality municipals, bonds issued by countries with solid balance sheets, and the debt and equity of global companies with iron-clad cash flows and debt dynamics.
"Persistent political dysfunction in the United States precludes the world's only superpower from properly controlling its economic destiny," he says. "And emerging economies, such as China and India, have gained influence but still lack the institutions to deliver on their new global responsibilities."
The Financial Times reports that the economies of Brazil, Russia, India and China did worse than Portugal, Italy, Ireland, Greece and Spain in 2011. As a group they were down 26 percent in US dollar terms, versus a decline of 23 percent for the bad boys of the eurozone.
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