Ben Fischer, Managing Director

NFJ

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In a conference call, NFJ co-founder Ben Fischer discussed how today’s market turmoil may create a timely opportunity to increase your international asset allocation. The following is an excerpt of the call.

We certainly recognize that we’re in a volatile market, but as contrarian investors, we believe in staying away from the crowd. We search for good companies in areas that may be weak today, but that we believe will be good places to be longer term.

That describes our view today of international investing. If we can endure what we believe is short-term volatility, and if we can gradually dollar-cost average into discounted, dividend-paying international stocks, we believe we will be better-positioned for the long term.

Short-term volatility leads to low prices

That said, I definitely understand that we’re in a very difficult economic environment.

• We’ve had the worst stock market correction that I can remember in my career.
• Times are very tough economically; we’ll probably see a lot of negative GDP numbers here and overseas.
• Emerging markets are under a lot of pressure, commodities are for sale and everybody is worried about tomorrow.

One of the immediate results of all this is distressed prices: current price-to-earnings (P/E) ratios are very low, whether you’re looking at reasonable forward earnings or trailing earnings. That’s attractive to NFJ right now, since we’re value investors and we’re confident we will get through this. This may be a global recession, but we don’t think it’s a depression.

Strong growth prospects outside the U.S.

There are many strong economies out there, including China, India, Japan and Brazil. And while they’re going through a tough period now, I don’t think they’re going to stop growing. The Chinese are going to continue to add to their infrastructure. They’re going to continue to build their electric power capacity, their railroads, their highways. They’ll all be using more energy and driving cars, and eventually the commodity slide will reverse and all the short-term dislocations will be behind us.

And when we get there, I think the pendulum will swing toward stronger activity outside the U.S.— and that includes countries like Australia, New Zealand and Korea. We have a lot of domestic credit problems that we’re going to have to work our way through, and I simply don’t think we’re going to grow quite as fast as the emerging markets over the next two to five years. Of course, investing in non-U.S. securities entails additional risks, including political and economic risk and the risk of currency fluctuations; these risks may be enhanced in emerging markets.

Government spending is on the way up in the U.S. Part of this is because, domestically, the Federal Reserve has really built up its balance sheet:

• Back in July, the Federal Reserve balance sheet was about $770 billion.
• In the beginning of November, it was about $2 trillion.
• Some estimates project that we’re going to go over $3 trillion soon.

So that’s an enormous amount of liquidity being pumped into the markets. At the present time, it’s been frozen in the money supply. Nobody is spending. Everybody is worried about the economy, so credit is not flowing, people are losing their confidence and all this liquidity is just sitting there.

Inflation will loom again

As a result, inflation is down quite a bit, and it should continue to stay low for the rest of this year and into next year. But to get through this tough period, we’re creating so much liquidity that it’s calling our currency into question. After all, it’s wonderful to owe debts in the currency that you print. That’s why, longer term, we don’t believe the U.S. dollar will be the place to be. Before 2015, I think we’re going to be looking at U.S. inflation of 5%–6% or higher.

Dollar-cost averaging as a defense

To defend against rising inflation, we believe you have to take a long-term view and try to steadily take advantage of the international opportunities that present themselves today.

That’s where dollar-cost averaging—or regularly investing a fixed amount of money over time—can help. This kind of a steady investment program imposes discipline, and it helps you take advantage of price fluctuations by buying more shares when an investment’s price declines, and fewer shares when it rises. And so if you gradually buy your way in over a period of time, which is what we’re doing now at NFJ, you may be able to build up a good position when prices are low. However, dollarcost averaging does not assure a profit and does not protect against loss in declining markets, and investors should consider their financial ability to continue their purchases through periods of low price levels.

Consider gradually shifting your international allocation

Of course, we certainly don’t think we can call the market, but we believe we’re closer to the bottom than we are the beginning of a big slide downward. That’s why we’re calling for a gradual increase in asset allocation toward the international side.

In the past, I felt comfortable saying that a 10%–20% international allocation was a pretty good diversifier. But this is an unprecedented situation: We’re talking about trillions of dollars in spending like people used to talk about billions, and I just don’t think our currency can withstand that over a five-year period. So I’d rather have some hedge against it. That’s why I’m calling for a higher international allocation than I used to―perhaps 30%–40%, maybe even higher―but over a period of months or quarters, not days or weeks.

Of course, I don’t have the ability to predict timing any better than anybody else, but I certainly know from experience what inflation can do to currency. And this is why I feel good about international markets long term.

Don’t forget about dividends

Another way to defend yourself today is to focus on dividends. At NFJ, we expect each stock we purchase to pay a dividend. If a company cuts or eliminates their dividend, we typically take the stock out of our portfolio—and keep in mind that there is no guarantee that dividend-paying stocks will continue to pay dividends. But the way we look at it, even if we have a flat period for a while, we should get paid while we wait. So even now, when fixed income looks pretty attractive without any inflation, I think we compete well because of the income we get from dividends.

The bottom line

Longer term, I think our international focus will make us better positioned when inflation comes back. It’s all about preserving real capital in the face of inflation by being where the growth is—and we believe that is in equities overseas. You’re going to have to broaden your asset allocation, take advantage of currently low valuations, look past the short-term volatility and seek out the best opportunities you can find. Some sectors and companies will do better than others, which is why we believe that experienced asset managers who focus on balance sheets and help provide downside protection can really help you over time. That’s what we’ve always done at NFJ.