Should investors buy good companies trading at historically attractive prices? According to conventional wisdom, this simple question has an equally simple answer - "of course" - that is supported by the vast majority of historical cases. But before acting on conventional wisdom, investors should ask themselves why so many unthinkables have turned into reality over the last few months. By doing so, they would be forced to consider important qualifiers arising from historic structural changes buffeting the global economy and, therefore, financial markets.

In its attempt to stimulate borrowing by making long-term money cheap, the Fed has harmed large swaths of savers. A look at three groups in particular proves instructive: pension plans, life insurance companies, and households saving both inside and out of 401(k)s.

Over the next 12 to 18 months, we expect the global economy to expand at a very modest real rate of 1% to 1.5% Global imbalances have continued to rise in the post financial crisis environment, global leaders continue to fail in their policy coordination efforts, and deleveraging and reregulation continue to be critical over the course of our cyclical horizon. We are transitioning into a world where we believe the incentives of policymakers and the divisiveness of politics will become the predominant drivers of investment returns and economics.

As labour demographics change, China could suffer a double whammy of a falling savings rate and a diminishing labour force. The size of its domestic market allows China to spend more on research and development (R&D) and so potentially build technology and scale more quickly than many foreign competitors. In particular, we have identified wheel loaders and excavators as two sectors where we expect the Chinese to successfully migrate up the value chain.

There were three culprits for last week's market dramatic sell-off: first, yet another downgrading of the outlook for global growth, including in the form of a stark warning from the Federal Reserve on "significant" downside risks (and, for an institution that selects its words very carefully, significant translates to something nearer to horrid); second, recognition that this situation increases the challenges facing policymakers who, for the large part, have been MIA for way too long; and third, a worrisome amplification of the crisis in Europe.

The longer policymakers wait, the more likely Europes financial crisis will deteriorate. The risk of a global liquidity trap has also increased as many healthy balance sheets around the world are also refusing to engage. Germany and other strong sovereign nations in Europe have to make a choice: continue to provide financial assistance to countries with more debt and assist in helping to restructure the debt of some European peripheral countries, or potentially move forward with a smaller, stronger group of countries-or at the extreme walk away from the Euro and the EU all together.

Many municipal balance sheets are in reasonably good shape and default rates remain a small fraction of the overall market. The downgrade of Americas AAA rating to AA+ had a knock on effect on municipal bonds. However, we believe of greater consequence to bond issuers, and to the market, is the outcome of federal budget negotiations. We feel essential service revenue bonds tend to have more consistent revenue streams and lower (or no) pension and medical liabilities than general obligation issues.

Central banks around the world consider easing monetary policy amid concerns of a global economic slowdown. At least one major central bank, however, appears to be taking an opposite stance: China. Policymakers there are concerned about inflation, excessive credit and property speculation. In other emerging nations, central bankers are generally poised to ease, but have less ammunition than they did after Lehman collapsed.

Global markets again find themselves in the uncomfortable back seat of a car driven erratically by policymakers. The hope is that policy responses in both America and Europe will enable them to build on last week's solid gains and, thereby, improve the outlook for jobs and economic growth. This can happen if most/all of what follows materializes. Top-down issues are still important drivers of markets. It is not a comfortable place for markets given the recent history of recurrent policy shortfalls and debacles. Yet it is also reality for now.

The euro should, indeed must, be saved. And it can be saved provided Europe is willing to make hard structural and institutional decisions. The time has come for the eurozone -- Germany and France in particular, but also Austria, Finland and the Netherlands -- to decide how they would like European integration to evolve; and they need to do so quickly. They have two conceptual choices: restore stability to the current, heterogeneous zone; or opt for a smaller but stronger one.

Unlike recent G-7 meetings of finance ministers and central bankers that were essentially ignored, there was quite a bit of interest in the one held this past weekend in Marseille. That interest turned out to be misplaced, however, as the G-7 delivered little of substance yet again. The G-7 issued a communiqu whose disappointing lack of content contrasts sharply with the deteriorating health of the global economy, the intense risks ahead, and legitimate policy confusion. The G-7 is fortunate that it is not required to justify the expenses of its meetings in terms of what is achieved.

At long last, President Obama did enough this evening to upgrade the quality of the nation's economic debate. He presented a credible program that is focused on the right structural areas. Now he must strengthen it and complement it with a sensible fiscal component; and Congress must discuss it in a cooperative and constructive manner. A lot is at stake, especially for those that have been jobless for too long but also for American society as a whole. Let us hope that Washington is, collectively, able and willing to follow through.

Many managers are focused on beating benchmarks, rather than helping clients achieve their investment objectives. Clients save and invest their money for specific reasons, such as for retirement or childrens education and managers should focus on helping them meet those goals. Many managers are really closet indexers masquerading as active managers while charging premium fees for benchmark returns. Many equity managers deviate very little from their benchmark because they are terrified of potentially underperforming it.

National and global realignments are fundamentally and durably changing the global investment landscape. Investors face the challenge of recalibrating some of the traditional parameters that are key to managing risk and delivering returns. There are also implications for investment management firms which are yet to be sufficiently reflected in the thinking and actions of the industry as a whole.

The concept of showering money over national economies to combat deflation has been an accepted principle of monetarism for decades. A helicopter, however, is not your average aeroplane, and the usual laws of aerodynamics do not necessarily apply in all cases. Similarly monetary policy at the zero interest rate bound introduces a new dynamic that may conflict or even reverse standard logic that lower interest rates across the sovereign yield curve are everywhere and always stimulative to economic growth.

Again, already fragile U.S. markets will be influenced by developments on the other side of the Atlanticand in a week in which there is great anticipation for President Obama's "mission critical" speech on the American economy. Europe's deepening debt and growth crisis amplifies the importance Obama's effort to deal with America's deepening unemployment and growth crisis; and does so by raising both the stakes and the challenges for the President. Tighten those seat belts. It will be a bumpy and volatile week as markets are held hostage to policy developments in both America and Europe.

Before the Jackson Hole meetings over the weekend, it was no surprise that all eyes were on central banks. They have demonstrated in recent years that they can act swiftly and decisively when they choose to. While eurozone governments have failed to maintain a united front to deal with a sovereign debt crisis, and American politicians have concocted their own budget crisis, central bankers have retained the moral and operational high ground. Yet, given the problems of growth in the U.S., and of growth, solvency and the coherence of the eurozone, there is a limit to what central banks can do.

Liquidity concerns may affect all European peripheral bond markets unless the European Central Bank counters the rush for the exits with an enlarged daily checkbook. In the U.S., discord between rich and poor has led to lower, not higher, Treasury yields as approaching recessionary winds force the Fed and private investors to favor bonds. We prefer investing in the cleaner dirty shirt countries of Canada, Australia, Mexico and Brazil, along with non-dollar currencies that have strong trade ties with the Asian continent.

It is tempting to dismiss all this market volatility as just irritating "noise" rather than insightful "signals". But, be very careful before you are opt for this seemingly comforting interpretation. There is a lot in play today that requires a bold response out of Washington. This is not just an American phenomenon. Europe is in a much worse situation. And, if policymakers on both sides of the Atlantic don't get their act together, they will run out of tools that have a chance of being effective circuit breakers. Things could get a lot worse before they get better.

While our secular outlook for emerging markets is solid, we expect long-term success will be earned by those who can manage cyclical risks. There is a tradeoff between the cost of establishing a hedge and the downside protection that it imparts to a portfolio. The best approach to tail hedging is a flexible one; using dynamic rebalancing, diversification and affordable option-like securities. A diversified macro approach to hedging tail risk actually may be more efficient for EM than it is for developed asset classes.

The Pathfinder Strategy is currently limited to only a handful of banks that are best characterized by PIMCO as deep value opportunities. We generally do not see meaningful upside potential in equity positions of developed market banks over the secular horizon. Our concerns primarily revolve around three factors: loan growth, balance-sheet risk along with capital levels and regulation.

The world economy is now in the grips of a damaging feedback loop involving deteriorating fundamentals, lagging policy responses and destabilised financial markets. If policymakers do not act boldly, and do so in a globally-coordinated fashion, the world risks tipping into a prolonged recession with worrisome institutional, political and social consequences.

?Taxpayers have been hoodwinked into believing the cost from profligate government spending is low relative to the benefits. The Keynesian revolution ignited a decades-long abuse of the core principle of Keynesian economics: for government to increase spending when private sector aggregate demand weakens and stymies job growth. The central banker is left to shoulder the burden, seeking all the while to pressure the fiscal authority to amend the abuse of Keynesian economics and decades of fiscal folly.

The European Central Bank has crossed the Rubicon. By buying Italian and Spanish government bonds, it has brought a much-needed and credible external balance sheet to bear. There is thus the potential for an end to damaging games of chicken between the eurozones monetary and fiscal authorities and, therefore, stabilizing the eurozones systemically important government bond markets. But there remains huge uncertainty, together with large technical and political execution risk.

?Taxpayers have been hoodwinked into believing the cost from profligate government spending is low relative to the benefits. The Keynesian revolution ignited a decades-long abuse of the core principle of Keynesian economics: for government to increase spending when private sector aggregate demand weakens and stymies job growth. The central banker is left to shoulder the burden, seeking all the while to pressure the fiscal authority to amend the abuse of Keynesian economics and decades of fiscal folly.

After Mondays gut wrenching 635 point fall, the Dow Jones index surged an impressive 430 points on Tuesday. In the process, investors experienced a wild 640 point intra-day roller coaster! Gold prices set another record while Treasury yields fell sharply, with the 2-year closing at an eye popping 0.2% and the 5-year at an equally stunning 1.0 percent. Tuesdays combination of unusual, if not unprecedented, market moves had a lot to do with the Fed. Once again, the institution came to the rescue of an equity market under severe pressure, and did so in a bold manner.

PIMCO has done much research over the last eight years of managing so-called tail risk for our clients, and weve come to the conclusion that flexibility and the use of all tools are paramount. The main difference between cash as a hedge against systemic risk and, say, put options is that a dollar of cash remains a dollar of cash regardless of the market, but option values change as either the underlying asset moves down or as the perception of risk changes. In short, we believe guarding against the tails is best achieved by a mix of approaches rather than blind adherence to one.

We believe the implications from the downgrade as well as the overall environment make a good case for muni investors to prefer essential-service revenue bonds over General Obligation (GO) securities. This is not the first time that we have seen the muni market face potential ratings downgrades. The muni market has become a market where credit analysis is increasingly important.

Surprises are not a new phenomena for money market and other short-term investors. Our sense is that that money-market funds and other short-term strategies seem well positioned for the aftermath of the downgrade. In the short-term, we believe U.S. Treasury bills will continue to be highly sought after as a short-dated liquidity alternative, especially by central banks. S&Ps downgrade should serve as another wake-up call to investors to continually determine their liquidity needs.

There will be endless debate on whether S&P, the rating agency, was justified in stripping America of its AAA rating and even attaching a negative outlook to the new AA+ rating. But this historic action has now taken place, and the global system must adjust. There are consequences, uncertainties, and a silver lining. Not so long ago, it was deemed unthinkable that America could lose its AAA. Indeed, risk free and US Treasuries were interchangeable terms so much so that the global financial system was constructed on the assumption that Americas AAA was a constant at the core.

Technical factors played a role in Thursday's unsettling market moves, including the disorderly across-the-board collapse in the price of risk assets in the final hour of trading and the related surge in U.S. Treasurys. But they were not the cause. Rather, they amplified three factors that will determine the fate of markets in the weeks ahead. First, it is now undeniable that the U.S. economy is weakening across the board. The second factor relates to confidence. Markets are worried that policymakers will not be able to put the economy back on the right path. And then there is Europe.

The U.S. has averted a debt crisis, but there remains a stain on our reputation. Nothing in the Congressional compromise reached over the weekend makes a significant dent in our $1.5 trillion deficit. In addition to an existing nearly $10 trillion of outstanding Treasury debt, the U.S. has a near unfathomable $66 trillion of future liabilities at net present cost. Aside from outright default, there are numerous ways a government can reduce its future liabilities. They include balancing the budget, unexpected inflation, currency depreciation and financial repression.

Politicians are taking an important step this weekend to remove the threat of a debt default and to focus more credibly on problems facing the economy. We should thank them for that. But we should also remind them that their work is far from done. Washington should waste no time in redoubling efforts to remove the multiple policy uncertainties and structural impediments that stand in the way of restoring America on the path of high growth and plentiful job creation. Anything short of that will imply further economic and social deterioration, and a greater erosion of America's global standing.

Neither Europe nor America can sustain the sort of economic recovery that would make a meaningful dent in their debt dynamics. As a result, different governments are opting for different approaches, including harsh austerity, financial repression and, in one case, a potential debt restructuring. De-levering pressures will be with us for years, and governments will mix and match from the menu of options. Accordingly, periodic debt dramas will recur. And we all need to understand the dynamics and the likely choices governments will make going forward.

A downgrade of U.S. credit could spark a new financial crisis. Would the impact be as great as when Lehman Bros. failed? Treasurys have been defined for decades as the risk-free financial instrument; faith in them is far stronger than it was in debt of Lehman. U.S. Treasuries are a $14?trillion market. Lehman had approximately $600?billion of liabilities before it failed, less than 5% of the size of the Treasury market. These factors suggest that a U.S. downgrade has the potential to be as bad, or perhaps worse, than the Lehman shock.

I am confident that Washington will find a way to compromise on a mini-deal, rather than a grand bargain, that raises the debt ceiling and avoids a debt default. They may even manage to evade a downgrade of the nations vaunted AAA credit rating, though this is more uncertain. But fiscal solvency is not merely a function of deficits and debt. It is also highly sensitive to economic growth: The lower an economys growth rate, the higher a budget deficit is likely to be, the larger the debt accumulation, and the greater the need for yet another round of fiscal austerity to safeguard solvency.

European politicians and bureaucrats may want to focus on their summer holiday plans rather than the eurozone sovereign crisis, but with Italy and Spain facing ongoing contagion they may have to forget their holidays and get to work. When the eurozone leaders finally got around to their summit on July 21, they no doubt hoped that the announcement of a new bailout plan for Greece and plans to expand the role of the European Financial Stability Facility (EFSF) would buy them some time. Unfortunately, that has not happened.

Oil exposure can increase equity beta in an investment portfolio. Historically, correlations between oil prices and equity prices have varied widely, depending on economic conditions. Determining whether oil price movements are driven by changes in supply or demand can help identify when the correlation between oil and stock prices is likely to be high or low. Investors can then know when exposure to oil is tilting their portfolios toward higher or lower equity beta.

?Identifying how much solvency relief Greece needs is complicated, not least because there is no magic debt ratio that is sustainable. Identifying how much political capital might be bought in European Union creditor countries and beyond is more straightforward. Contagion risks are positively correlated with any benefits Greece might experience from a potential restructuring.

As the economy undergoes important realignments, investors will need to rethink their traditional approaches to managing their portfolios. As the lines between interest rate and credit risk become blurred, finding sources of safe spread becomes even more critical. More, not less, discretion is warranted when navigating volatile global markets, avoid sectors affected by financial repression and hedge against inflation and/or adverse tail events. We believe investors need to look at risk factors rather than traditional asset classes when making asset allocation decisions.

Given renewed concerns over liquidity and credit, investors can potentially do better by considering actively managed short-term strategies that invest beyond traditional U.S. money-market guidelines. The current credit situation in Europe is different from that in both 2008 and 2010 because initial liquidity conditions in the short-term markets are better. In our view, investors should evaluate potential investments within the wider scope of relative value opportunities and not simply for the incremental yield they may offer above risk-free returns.

Headwinds to housing demand, and thus the overall market, could last for years. It appears that limited mortgage availability and vulnerable consumer health are restraining demand. Also weighing on the market is regulatory uncertainty over the future structure of mortgage finance and the resolution of foreclosure overhang. We believe the housing market, considered to be a key driver of the economic recovery, will generally remain weak for the foreseeable future.

We forecast emerging economies will expand at a faster pace than advanced economies over the secular horizon. The challenge for emerging market central bankers is to remain ahead of inflation expectations and retain credibility on inflation targeting. We feel they are well positioned for this. We believe global investors remain significantly underweight emerging market assets. We expect this underallocation to decrease, providing multiyear support for the asset class.

Europe has been applying a liquidity solution to a solvency problem. The approach, which has bought time, is near exhaustion as it has failed to improve debt sustainability, restore access to markets and put in place the conditions for sustainable growth. Time is approaching for a radical change, with policymakers potentially facing two options. They could opt for greater fiscal union to include cost-effective guarantees and transfers, rather than just loans, in exchange for individual countries sacrificing a significant amount of national sovereignty.

Equity investors may look in unfamiliar places as they navigate potential shifts in the global economy. An apparent rebound in risk tolerance since the financial crisis has supported higher equity valuations. Emerging market economies appear to be undergoing a mid-cycle rebalancing. We view this as a welcomed cyclical adjustment rather than the end of their growth cycle; long-term fundamentals remain intact. We believe advanced economies should continue to see headwinds to growth, and that potentially means investors may be generally willing to pay lower multiples to earnings.

To address its economic woes, America needs to transition from a series of ad hoc measures to a more holistic policy approach. Aided by President Obamas personal and highly visible involvement, politicians are likely to meet the August 2nd debt ceiling deadline. A "grand bargain" can serve as the catalyst for unifying diverse policy actions into clearer, more comprehensive drivers for growth and medium-term fiscal sustainability. This would intensify pressure on other systemically-important parts of the world-particularly Europe and China-to join the US in striking their own grand bargains.

?By imposing austerity programs,t he U.K. is hoping to free up resources that can be devoted to pay down debt. The U.S. is hoping to create resources to pay down debt via economic growth ? an approach that can have disappointingly narrow feasibility. Other options include restructuring or defaulting on debt, inflating out of it and imposing financial repression by paying creditors less than they deserve.

Europe?s debt problem is a headwind for what remains a disappointing U.S. economic recovery. There is now broad-based recognition of America?s persistent economic weakness. The Federal Reserve has been forced again to revise downwards its growth projections for both 2011 and 2012. In order to avoid a repeat of the total Lehman paralysis in the face of an external shock to the U.S. economy three conditions must be met: a banking system that remains robust, no disruptions to money market funds and limited blockage to the plumbing of the country?s payments and settlement system.

International capital is flowing to countries with good growth prospects and to countries with central banks confident enough to raise interest rates. Certain nations are placing controls on capital or intervening in currency markets with an eye to maintaining economic competitiveness. We see central banks in the U.S. and the U.K. winding down monetary stimulus that has exacerbated the situation. Also, we see potential for emerging market currencies to appreciate, and that may give developed nations a boost.

We are seeing signs of what we have long suspected: There never was a housing recovery. The market is in an arguably fragile state that we believe is far easier to break than to fix. If we ended government support, mortgage rates could rise significantly, because home loan investors would need to be compensated for greater credit risk, and loan availability could decline. Those two factors would put downward pressure on home values.