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Portfolio > Economy & Markets

PIMCO's Gross Sees Lower Market Returns Ahead

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The perspectives shared by PIMCO Managing Director Bill Gross and his colleagues, such as Mohammed El-Erian and Paul McCulley, have earned them respect and a popular following before and during the financial crisis.

Their latest viewpoint: “Global financial market returns stand at the threshold of mediocrity,” wrote Gross in his July 2010 “Investment Outlook.”

This means that investors should expect lower returns. However, they can also take advantage of current conditions to buy some quality companies at low prices, says PIMCO portfolio manager Charles Lahr.

Overall, the leader of the bond giant calls for coordinated action on the part of policymakers worldwide: “It is this lack of global aggregate demand – resulting from too much debt in parts of the global economy and not enough in others – that is the essence of the problem, which only economists with names beginning in R seem to understand,” he said.

“With bonds priced not for recession but near depression, most major global bond indices now yield less than 3%, surely a forerunner of returns to come,” Gross explained. “Stocks, long the volatile vamp of investor optimism, have not yet adjusted to the ‘New Normal’ of half-size economic growth induced by deleveraging, reregulation, and deglobalization and have low single-digit prospects as well.”

With higher debt on all fronts and lower population growth is some developed economies, “Not only will it become more difficult to transfer high existing debt burdens onto the smaller shoulders of future generations, but the overleveraged, aging “global boomers” themselves will demand a disproportionate piece of stunted future goods and services – without, it seems, the ability to pay for it,” Gross added.

As for the need today for improving demand worldwide, “Developed nation consumers are maxed out because of too much debt, and developing nations don’t trust themselves to stretch their necks for the delicious leaves of domestic consumption just above,” he explained.

“If policymakers could act in unison and smoothly transition maxed-out indebted consumer nations into future producers, while simultaneously convincing lightly indebted developing nations to consume more, then our predicament would be manageable,” Gross concluded. “They cannot. G-20 Toronto meetings aside, the world is caught up as it usually is in an “every nation for itself” mentality, with China taking its measured time to consume and the U.S. refusing to acknowledge its necessity to invest in goods for export.”

“We have arrived at a New Normal where, despite the introduction of 3 billion new consumers over the past several decades in ‘Chindia’ and beyond, there is a lack of global aggregate demand or perhaps an inability or unwillingness to finance it,” shared Gross.

“Slow growth in the developed world, insufficiently high levels of consumption in the emerging world, and seemingly inexplicable low total returns on investment portfolios – bonds and stocks – lie ahead,” he concluded.

Buying Opportunities

Still, Charles Lahr, an executive vice president and portfolio manager with PIMCO, does see some good buying opportunities.

“Europe is clearly an area where value investors should be dedicating some time and effort. Many equities in Europe are down for the right reasons, including exposure to sovereign debt in problematic nations like Greece, Portugal or Spain. However, plenty of other companies are not exposed to sovereign risk thanks to their substantial foreign operations and other factors, yet they have been down substantially with the overall market in Europe, trading at meaningful earnings multiple discounts to their U.S. counterparts.”

“Also, as long as stocks remain depressed in Europe, their dividend yield in aggregate could be about double that of the U.S., providing a more attractive level of current yield,” Lahr noted.

As for developing economics, just as in the developing nations, it pays to pick stocks carefully, according to Lahr. “Looking ahead, we think equity investors are likely to generate the greatest alpha, or excess return, by buying the equities that are most undervalued and that’s not necessarily in emerging markets,” he explained.

“We’re looking for securities trading for 60 cents that we believe are actually worth a dollar. While it’s still possible to find equities like these in the emerging markets, you tend to find fewer of them in markets with such buoyant outlooks,” shared Lahr.

Overall, the portfolio manager notes, even with volatility “this is a great time to be a value investor, because volatility tends to beget opportunities over the long run.”

Many companies get sold for the wrong reasons, and if you have the ability to go in and identify individual names that are being undervalued by the market and make prudent investments, you’re likely to find some very attractive opportunities.”


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