Whale-sized investors, financial market oceans, large fish (the Federal Reserve), small fish (banks)—PIMCO chairman Bill Gross certainly drinks his fill of briny metaphors in his June market commentary. Gross writes that, “Soaring debt/GDP ratios in previously sacrosanct AAA countries have made low-cost funding increasingly a function of central banks as opposed to private market investors.”
This leads to a frightening conclusion: that both lower quality and lower yields of such “previously sacrosanct debt represent a potential breaking point in our now 40-year-old global monetary system.”
“[This possibility wasn’t] considered feasible as recently as five years ago,” Gross writes. “Now, however, with even the United States suffering a credit downgrade to AA+ and offering negative 200 basis point real policy rates for the privilege of investing in Treasury bills, the willingness of creditor whales—as opposed to debtors—to support the existing system may soon descend.”
Gross adds that the global monetary system, which has evolved and morphed over the past century but always in the direction of easier, cheaper and more abundant credit, may have reached a point at which it can no longer operate efficiently and equitably to promote economic growth and the fair distribution of its benefits. Future changes, which lie on a visible horizon, “may not be so beneficial for our ocean’s oversized creatures.”
So what’s to be done?
The solution points toward higher global inflation to solve overextended debt-ladened balance sheets, he warns. Therefore, bond investors should favor quality and “clean dirty shirt” sovereigns (U.S., Mexico and Brazil), as well as emphasize intermediate maturities that gradually shorten over the next few years.
“Equity investors should, likewise, favor stable-cash-flow global companies and ones exposed to high-growth markets. Investors in general, however, will be hard pressed to repeat the rather right-tailed performance of the past 30 years, a whale rather than plankton-dominated era based on excessive credit expansion. Deleveraging economies and financial markets present a different and lower returning kettle of fish than did recent credit-dominated decades.”
He concludes by noting the current obsession with Europe, which he dismisses as a “localized tumor.”
“The developing credit cancer may be metastasized, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies waiting on the horizon. Investors should sail carefully, and the Wall Street 1% should put on their life vests if they expect to weather the inevitable storm that may threaten the first-class cabins they have come to enjoy.”