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April 01, 2015 at 10:44 AM
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.
