A glum Bill Gross argues the investing environment has grown so “hostile” that he is reduced to trading more than owning bonds as a means to deliver some kind of shareholder return.
The Janus bond manager’s April investment outlook returns to a familiar theme for Gross: his quest for the “new neutral rate” for the next 5 to 10 years, which he now estimates as zero.
The calculation, which he goes over in wonkish detail, is significant because just last summer he discerned the neutral rate — a target policy rate that reflects but is lower than real GDP — as reaching 2% by 2017, thus suggesting a far gloomier view of the economy over the coming years.
“The lower real rate/capital gains ocean liner has taken us into uncharterd waters, but waters, which we must know, that are hostile to investors,” writes Gross, after noting that his estimated zero rate implies “an inability of savers and investors to earn sufficient returns to satisfy presumed liabilities.”
Gross discusses four models for earning investment returns in a levered economy that cannot function with anything but very low rates.
(As he illustratively quips: “It was a 3% real rate of interest in the U.S. that broke the levered global economy back in 2006/2007; a rate that may have been appropriate 20 years before when credit as a % of GDP was 200% instead of 350%, but not in 2006, when the obvious micro example of a 1% short term teaser rate on a $500,000 home in Modesto, California, became a Libor + 3% loan shortly thereafter, and broke the back of the U.S. housing market.”)
The first approach to investing in a 0% real rate environment — that of Bridgewater Associates’ Ray Dalio and Robert Prince — is through cautiously levering; that is, borrowing short term to invest long term.
A second approach is that of GMO Asset Management’s Jeremy Grantham, who suggests going to cash for a seven-year period until mean reversion restores market opportunity. That approach, Gross warns, will underperform if markets don’t crash as Grantham expects.
A third approach is that of Warren Buffett, “who has the benefit of a near perpetual closed-end fund purchasing stocks when fundamentally cheap.”
A fourth approach is that of Vanguard founder John Bogle, who argues that investors can’t know where markets are headed but can control how little they pay for investment management.
The Janus manager says his approach is most similar to the Bridgewater approach, but he warns that to succeed, that alpha-seeking approach depends on selecting the right assets on which to go long — a difficulty further complicated by an environment in which “almost all assets are artificially priced.”
Gross specifies, as a case in point, the artificially priced assets he currently prefers — and his technical trading approach to extracting value from them:
“The most attractive opportunity to me rests with the notion that Draghi’s 18 month QE, which roughly purchases 200% of sovereign net new issuance during that time, will keep yields low in Germany and therefore anchor U.S. Treasuries and UK Gilts in the process.
“I would not buy these clearly overvalued assets,” the bond manager continues, “but sell ‘volatility’ around them, such that much higher returns can be captured if say the German 10-year Bund at 20 basis points doesn’t move to –.05% or up to .50% over three months’ time.”
The strategy reflects what Gross regards as today’s investing challenge — purchasing artificially priced assets “that might remain artificially priced over one’s investment horizon.”
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