Bond manager Bill Gross explains PIMCO’s outperformance through an approach that doesn’t fight the Fed, but rather deflects its easy-money approach through a retreat from risk.
In his new December investment outlook, the manager of the world’s biggest bond fund argues that the Fed, the Bank of Japan, the European Central Bank and the Bank of England are jointly telling the world’s investors “you have no other choice” but to move out on the risk spectrum.
The central banks’ policy of keeping interest rates at the zero bound has kept rates artificially low, thus creating a “dangerous game…in a desperate gamble to promote growth,” Gross writes.
But because the gambit has not worked — “monetary and fiscal policies cannot produce the real growth that markets are priced for” — Gross says the more astute investors at the margin (he includes Bridgewater and GMO along with PIMCO) are finding ways to steer away from risk.
“Deep in the bowels of central banks’ research staffs must lay the unmodelable fear that zero-bound interest rates supporting Dow 16,000 stock prices will slowly lose momentum after the real economy fails to reach orbit, even with zero-bound yields and QE,” he writes.
Gross cites, and modifies, his colleague Mohamed El-Erian’s concept of a “T-junction” investment future “where markets approach a time-uncertain inflection point, and then head either bubbly right or bubble-popping left due to the negative aspects of fiscal and monetary policies in a highly levered world.”
The bond manager proposes an altered metaphor of eagles’ wings, which resemble a “T,” but which slope more gradually on either side. Thus, the taper talk back in April moved the bond market “two steps upward, one step back” along the eagle’s wing and thus it will continue, slowly, until the ultimate crisis.
For that reason, savvy investors can prepare, as PIMCO has, by limiting risk through an underweighting of duration and overweighting of “carry alternatives such as volatility, curve and credit,” an approach Gross says has generated alpha to PIMCO investors “with the aim of outperforming Vanguard as well as many other active managers,” he writes.
In the meantime, the bond manager reiterates his longstanding view that the Fed will maintain low rates until 2016 or beyond—till such time as unemployment comes down to 6.5% and inflation rises to at least 2%.
Though he pictures a gentler eagles’ wing-unwinding, Gross concludes that “overlevered economies and their financial markets must at some point pay a price, experience a haircut, and flush confident investors from the comfort of this Great Moderation Part II.”
Check out PIMCO’s Gross Calls for Tax Hike on Rich, Laments 1% ‘Scrooges’ on ThinkAdvisor.