May 9, 2012

PIMCO’s Gross: Focus on Short-Term Securities, QE3 Is Coming

Bond king says real assets, commodities should occupy increasing percentage of portfolio

With the global economy “floating on an ocean of credit,” the current acceleration of credit via central bank policies will likely produce a positive rate of real economic growth this year for most developed countries, PIMCO chief Bill Gross writes in his latest monthly commentary, but “the structural distortions brought about by zero bound interest rates will limit that growth and induce serious risks in future years.”

PIMCO's Bill GrossGross (left) adds that “not suddenly, but over time, gradually higher rates of inflation should be the result of QE policies and zero bound yields that will likely continue for years to come.”

The central bank policies to which he refers appear to be another round of quantitative easing from the Fed, also known as QE3. Showing his technology and new media chops, Gross added to the debate on Tuesday by tweeting that the decision to buy more debt is “getting closer.”

In his monthly commentary, Gross engages in an extended explanation of the rise of the concept of credit in the modern world, before asking, “Yet how much credit is too much credit and how is a dedicated central banker to know?

The job of modern-day central bankers—Bernanke, King, Draghi and their global counterparts–is to decide how to control a “beneficial chain reaction” without it getting out of hand, he answers. “In many ways they are like their Wild, Wild West counterparts, trying to convince skeptical depositors that the gold will always be there.”

“What they should know … is that when QE and QE2 lapsed in recent years, stock prices declined by 10%–15% until magically they came back to live another day. The same stunting effect can be observed in the bond market when measured by real as opposed to nominal interest rates. They go down with QEs and up in their absence.”

Because of QEs, the associated “twist,” and similar policies by the Bank of England (BOE), Bank of Japan (BOJ) and Eropean Central Bank (ECB), he adds, several trillion dollars of “base money” has been added to global central bank vaults. Rather than “dug out of the ground, this credit has been created at the stroke of a pen or a touch of the keyboard in today’s electronic monetary system.”

“Part productive, but increasingly destructive, the current acceleration of credit via central bank policies will likely produce a positive rate of real economic growth this year for most developed countries, but the structural distortions brought about by zero bound interest rates will limit that growth,” Gross concludes.

“In addition, inflation should creep higher. Do not be mellowed by the affirmation of a 2% target rate of inflation here in the U.S. or as targeted in six of the G-7 nations. Not suddenly, but over time, gradually higher rates of inflation should be the result of QE policies and zero bound yields that were initiated in late 2008 and which will likely continue for years to come. We are hooked on cheap credit just as Wimpy was hooked on Friday’s burgers,” he said, referring to Wimpy from the Popeye cartoons.

His recommendation?

“Focus on securities with shorter durations—bonds with maturities in the five-year range and stocks paying dividends that offer 3%–4% yields. In addition, real assets/commodities should occupy an increasing percentage of portfolios.”

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Check out Bill Gross' recent outlook of the U.S. economy at AdvisorOne.

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