Janus fund manager Bill Gross says that happiness has been dominating stocks while despair has taken over global bond markets.
“Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the dollar/euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017,” he explained in his January letter to investors.
Economic growth expectations have been lifting equities since the election of Donald Trump.
However, risks concerning higher inflation and a more hawkish Federal Reserve are why the 10-year Treasury has moved 100 basis points, from 1.40% to 2.40% since November.
“Are risk markets overpriced and Treasuries over-yielded? That is a critical question for 2017,” Gross writes.
He acknowledges that the Federal Reserve is tightening, but points out that other central banks are conducting $150 billion of monthly buybacks.
This means global arbitrage “effectively caps the 10-year at 2.4% to 2.6% levels,” he says.
Plus, there are “currency adjusted yield pickups” of 70 basis points — accomplished by selling 10-year Japanese government bonds or German Bunds and buying U.S. Treasuries — and this has led to the artificial pricing of the U.S. 10-year, “even as inflation moves higher and short-term yields are raised by the Fed once, twice, or three times in the next 12 months,” according to Gross.
These fundamentals can be confusing. But technical indicators show “a super three-decade downward sloping trend line for 10-year yields” that could prove to be critical to bond investors.
The Janus fund manager says that there are many influencing factors that “obscure a rational conclusion that yields must inevitably move higher during Trump's first year in office.”
Analyzing data and trend lines leads Gross to the conclusion that 10-year yields have been moving downward since the early 1980s, with 30-basis-point declines on average for the past 30 years. This has lowered the 10-year from 10% in 1987 to 2.40% today.
“Now, however, this super strong, frequently tested downward trend line is at risk of being broken: 2.55% to 2.60% is the current ‘top’ of this trend line, and over the past few weeks it has held and reversed lower by 15 basis points or so,” he explained.
Gross cautions that if 2.60% is broken on the upside — in other words if yields go beyond 2.60% — then “a secular bear bond market has begun.”
As for higher economic grow, “President-elect Trump tweets and markets listen for now, but ultimately their value is dependent on a jump step move from the 2% real GDP growth rate of the past 10 years to a 3%-plus annual advance,” Gross said.
Can he accomplish this? “We shall see …,” Gross said. “To do so would require a significant advance in investment spending, which up until now has taken a backseat to corporate stock buybacks and merger/acquisition related uses of cash flow.”
He is skeptical about 3% growth but is “more confident” of 2%. Why?
The aging U.S. population, high debt-to-GDP ratio “now more at risk due to rising interest rates,” the growing replacement of human labor by robots and other technology and weakening globalization, which “pose negative ongoing threats to productivity and therefore GDP growth,” according to Gross.
While Trump's policies may produce a brief acceleration in GDP over the next few years, the 2% longer-term standard should remain, he writes, and “that will stunt corporate profit growth and slow down risk-asset appreciation.”
--- Check out Bill Gross Likens Trump’s Policy-by-Twitter to Mussolini on ThinkAdvisor.