Anthony Crescenzi is a portfolio manager at PIMCO's Newport Beach, Cal. office. Prior to that, he was chief bond market strategist at Miller Tabak & Co.
Crescenzi authored one of the few books available on macro investing, titled Investing From the Top Down: A Macro Approach to Capital Markets.
He speaks to IBTimes about the main ideas in this book.
In the first part of the interview, Crescenzi outlines his view of the global economy. In the second part, he shares some tools he uses to monitor it.
Part I : Views on the Broad Economy
IBT: What drives the trends and cycles in the broad economy?
Crescenzi: Ultimately, what drives economic cycles is productivity gains. It defines a nation's standard of living. If a nation produces more units per hour of working, the standard of living will be better.
Compare the amount of 'stuff' to 200 years ago, there is far more output per hour than there used to be and we enjoy the benefits of that as citizens of this society.
IBT: And what drives productivity gains?
Crescenzi: It requires innovation. The U.S. and Japan are innovative. China is becoming increasingly so, certainly in the low-end of the product spectrum.
Korea is an innovative nation; its [success] in the semiconductor industry shows that.
Cost of capital is important. Low cost of capital is needed relative to the return on the capital or investments. Property rights are important so that innovator and producer will believe that their output will be protected against [confiscation].
A sound regulatory structure [is needed]. A good financial structure to facilitate the raising of capital through banks and capital markets [is needed].
Those are the important elements to productivity.
IBT: What's your outlook for the major countries of the world regarding these factors of productivity?
Crescenzi: The U.S. has been in a productivity upswing since 1995 when the technology shock hit. Productivity booms and busts last about 20 years. We have some data showing this; there is evidence of these productivity cycles.
At a minimum, there is evidence that productivity cycles last a long time. The current one is still in play. This boom is enjoyed by many other countries in the world. The developing world is beginning to achieve productivity gains. Innovation in these countries is improving, in part because of the things I mentioned -- like the lower costs of capital.
These countries now have high savings pools, which are usually equated to strong rates of growth and investment and capital spending, and those are associated with gains on productivity.
The United States is still likely to benefit from previous investments for some time to come, even if there aren't [new] investments in the future. It is still in the midst of realizing [the gains of previous] investments.
IBT: What are some possible shocks to your baseline scenario?
Crescenzi: The tail-risk is that austerity measures in the developed world are made larger [than they already are] because of pressures from the market. This would cause a weakening in economic activity, [which may give companies reasons to hesitate on spending and investing.]
Europe is the region most challenged by this, so the risk would likely emanate from there.
Part II : Tools to Monitor the Economy
IBT: How do you monitor these trends you're talking about?
Crescenzi: We worry about tail risk in the developed space, so we track credit default swaps (CDS) [on the sovereign debt of developed countries], which is investors' assignment of the risk of default on these countries.
In Europe, one would want to look beyond the periphery into the CDS of Spain and Italy, to see if investors are worried that the problems will contaminate core Europe, [possibly countries like] France.
You [also want to look at] the credit spreads of Spain and Italy relative to core Europe. Again, if there is a problem, yields on Spanish and Italian debt would likely rise sharply relative to German and French yields.
I'd also add in the money market. Money market rates would rise sharply in the case that sovereign debt issues are becoming a greater concern to market participants. For example, the 3-month LIBOR [The London Interbank Offered Rate] rates would move up sharply if concerns were growing. It happened in May 2010; it happened recently a little bit.
In May, there was a lot of focus on Europe.
The money market, one could argue, is 'ground zero' for concerns in the banking system. The international banking system would be put under stress in a case where sovereign debt problems were perceived to be growing. LIBOR is the easiest to track for [monitoring] money market rates.
IBT: How do you measure the progress of the economy in your baseline scenario?
Crescenzi: The ultimate barometer is the labor market. What would drive improvement in the labor market is final demand. So we want to track consumer spending and business spending to see if 'escape velocity' is being achieved.
Escape velocity means if the U.S. economy is moving beyond growth that is rooted in government spending and inventory investment toward more sustainable sources of growth, which are related to final demand.
A hand-off needs to occur.
When consumer demand picks up, that ignites a virtuous cycle of self-reinforcing increases in production, income, and spending. New data on retail sales seem to support [the case] that the U.S. is tentatively achieving escape velocity.
Perhaps that will lead to gains in employment that will keep the self-reinforcing cycle in place. That's one of the biggest gauges.
The financial market itself will be a good gauge. The Federal Reserve is trying to achieve a rebalancing act and boost asset values in order to boost consumption. It goes back to the initial point about consumption.
But market [performance] levels of risk assets, like equities, is important to trends in final demand.
The overhang of debt in the developed world is an important secular headwind that isn't easily offset by cyclical tailwinds.
What could happen is that the economies muddle through the secular problems; they don't grow quickly, but they grow nonetheless. They become a bridge to a point where the secular problems fade in two, three years time or who knows how long.
Cyclical tailwinds are probably strong enough to permit a muddle-through scenario, but secular headwinds will remain in place. It's not the dominant force, but an important one that shapes the rates of growth.
IBT: Anything more you want to share about the book?
Crescenzi: What's happening in markets and economies worldwide is very much a macro issue. The behavior of markets reinforces the notion that investors need look beyond simply from the bottom up when making investment choices.
Sometimes the top-down can explain much of the behavior of the market, and therefore investment performance. Recent events reinforce the importance of tracking big picture events.
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