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July 01, 2011 at 08:00 PM
(Chicago) PIMCO Co-Chief Investment Officer Bill Gross painted a gloomy picture of U.S. investment prospects during his opening keynote address at the Morningstar Investment Conference in Chicago on June 8. The high-profile bond portfolio manager encouraged the audience of financial advisors to seek investment opportunities outside the Treasury market and away from dollar-based markets more generally. Gross noted that real, or inflation-adjusted, interest rates, as indicated by pricing in the five-year market for Treasury Inflation Protected Securities (TIPS), have fallen from about 4% in October 2008 to minus 0.5 percent today.
Such negative rates benefit debtors, including the U.S. government, but amount to “picking the pockets” of investors and savers, he emphasized. The drop in interest rates has put a damper on the prospects for U.S. stocks as well as bonds, he added, since equity prices cannot be expected to benefit from further drops in rates. “If real interest rates cannot go much lower, stocks are on their own. The bird is out of the nest,” Gross said.
“Get out of [negative] real interest rate space, and find something more attractive,” he suggested. In particular, Gross cited Brazil, Mexico, Canada and Germany as countries meriting investor interest. Brazil, Gross acknowledged, has currency risk and country risk reflecting a history that includes defaults on government debt. However, he noted that real interest rates in Brazil have lately been 6 percent and higher.
Gross denounced the high levels of U.S. government debt as a form of “financial repression” that damages the ability of investors to benefit from their assets. He contrasted this with policies in Canada, which he said “has a much cleaner balance sheet,” and in Germany, noted for its fiscal conservatism. “You don’t have to go too far afield in terms of developing countries to find less repressive countries than the U.S.,” he said. He did, however, suggest that some U.S. companies remain attractive investments because they offer high dividends and extensive exposure to foreign markets. He cited Coca-Cola, Johnson & Johnson and Procter & Gamble as examples.
Gross likened the predicament of investors whose assets gradually erode because of negative real interest rates to that of the proverbial frog sitting in a pot that’s gradually heated until it boils. He amplified on the amphibian theme by citing a frog that escapes from a pitcher of milk by energetically churning its legs to find an alternative situation. “Don’t be a frog,” said Gross. “And if you are a frog, be one in a pitcher of butter.”
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Recent gloom about a possible wave of municipal bond defaults got a dismissive response from a panel of muni bond portfolio managers at Morningstar on June 10. “The predictions of widespread defaults that are going to decimate municipal bond portfolios are completely preposterous,” said panelist Michael G. Brooks, senior portfolio manager at AllianceBernstein, as the discussion opened. The panelists were Brooks; John Cummings, head of the municipal bond desk at Pimco; and Lyle Fitterer, head of the tax-exempt fixed income team at Wells Capital Management. Moderating the discussion was Miriam Sjoblom of Morningstar.
Public anxiety about the muni market was stoked last December by a “60 Minutes” segment in which high-profile financial analyst Meredith Whitney predicted “significant” muni defaults and “hundreds of billions” in losses for investors. That prediction brought a “collective gasp,” recalled moderator Sjoblom. The reaction of the June 10 panel, however, was more of a collective yawn. “Sensationalism [about massive defaults is] doing a disservice to investors by putting fear in their minds,” said Fitterer, who added that such fears also have created some opportunities to buy munis cheaply. “Default is a tiny risk because issuers do not want to be shut out of the credit market,” said Brooks. The AllianceBernstein manager pointed out that municipalities, unlike corporations, do not have options of “moving to Barbados” and therefore must plan on maintaining an ability to borrow in the future.
Pimco’s Cummings assessed munis as a relative bright spot in his firm’s outlook on bond markets. “We think that municipal bonds are attractive relative to other U.S. fixed income assets for a U.S. taxpayer,” he said, noting that munis “do not protect you from a drop in the dollar and they do not protect you from an increase in inflation, but they do protect you from an increase in tax rates.” “Clearly tax rates are going to be higher in the future than they are now,” said Brooks, adding that munis will remain attractive for tax purposes barring a development — which he thinks unlikely — such as Republican presidential hopeful Tim Pawlenty’s proposal to eliminate taxes on interest and capital gains.
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