THE BLOG

It's Not a Hat!

01/14/2014 01:35 pm ET | Updated Mar 16, 2014

At the age of six, the narrator of The Little Prince, a well-known 1943 novella, gave up his career as an artist. His drawing of a hat, as it was perceived by grown-ups, versus his intended rendering of an elephant swallowed by a boa constrictor (for all the accepting children among us), could not pass judgment of the fancy art world. Somewhat disillusioned, he decided to grow up and pursue a "real job," dealing with facts and numbers.

When studying our numbers, 2013 remains a stellar year for many global equity investors, and yet we need to be reminded of another elephant, but this being the proverbial one in the room. Over the past six years, (only) four of the major Central Banks, namely in the U.S. (Fed), Europe (ECB), Japan (BOJ), and China (PBOC), managed to collectively expand their balance sheets by nearly $9 Trillion (+150 percent), mostly in support of ailing banks and local economies -- a sizable contribution, and equal to more than half(!) of U.S. GDP (at 2012 figures). Recent decisions by the Bank of England and the ECB to leave short-term rates at historic lows are clearly indicative of the fact that the global socioeconomic system continues to rely on the support of accommodative monetary policies.

All good intentions aside, the Central Bank magic hat trick may ultimately end in vain. According to a recent working paper by the International Monetary Fund (IMF), we, as grown-ups, may simply be incorrect about the ability of policymakers to provide a long-term fix to the global debt overhang and its related economic impact of subpar growth in numerous mature economies. A more common belief, according to the research, that developed nations can be held to a different standard when compared to emerging countries, is simply a function of denial. In consequence, the future toolkit to rebalance developed financial systems, similar to what has been applied in Emerging Markets post recent crises and throughout history, will include debt- restructuring/conversions, financial repression, and the tolerance for higher inflation... or a combination of all three factors.

Reflecting on the IMF paper, asset allocation and portfolio construction considerations need to include another dimension: it will be essential to also contemplate the return of assets versus the more common, and often singular, approach of receiving return on assets (performance). Investors and their advisors need to aim for high quality, optimal liquidity, and creditworthiness of counterparties and issuers, the latter aspect especially important with respect to fixed income markets and deposits held with financial institutions.

"All grown-ups were once children... but only few of them remember it," as the Little Prince so famously noted. At times, it is helpful to accept reality behind the drawings -- or numbers, for our purpose.