PIMCO bond manager Bill Gross says current fears of an asset bubble are “unfounded” and that stocks, bonds and real estate have room to run.
In his May monthly investment outlook, the manager of the world’s largest bond fund says “investors could draw some comfort from a low-returning yet less volatile future.”
The basis for this reassurance derives from the academic debate, which Gross reviews, swirling over what is the correct long-term neutral policy rate, which “forward markets” anticipate at 4%, but which Gross, citing multiple studies, pegs at close to 2%.
“If the neutral policy rate was 2% instead of 4% then bonds, instead of being artificially priced, would be attractively priced,” Gross writes, adding:
“Bonds would shed the ‘certificates of confiscation’ label for yet another decade or so, as this 2% neutral policy rate delevered the economy without igniting inflationary fears.”
The delevering is key to understanding the significance of this debate. Fed monetary tightening a decade ago was based on a standard application of the so-called Taylor Rule that seeks to make credit more costly in order to stem inflation. What the Fed of that time failed to grasp was that the economy had become so leveraged that it could no longer function under that model.
As Gross puts it:
“Interest rates have to be lower in a levered economy so that debtors can survive, debt can be reduced as a percent of GDP, and economies can avoid recessions/depressions!”
A 4% rate would assure a half-decade-long bear market, which the Fed is assiduously working to avoid, Gross argues, adding that the resulting financial repression comes at the price of reduced future returns: “potentially 2% instad of 4% for cash; maybe 3% instead of 5% yields for 10-year Treasury bonds; 4% returns instead of 5%-7% for stocks,” he writes.
Gross also offers a warning for pension funds that typically assume high rates of return in the 7%-8% range.