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Bill Gross: Deficits Plus Demographics Equal Disaster

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If you think the markets are having a tough start to 2016, of course, you’re right. But don’t read Bill Gross’ latest take on investing trends for this year if you are looking for any sunny predictions.

While the Janus Capital portfolio manager (and founder of PIMCO) doesn’t share his pessimistic views of specific stock sectors and markets, he hammers home the dismal fiscal and demographic situation of the United States in his January outlook.

“It’s a wonderful life for the 1% and a Xanax existence for the 99,” he explains.

“Kidding aside,” Gross adds, “… if the 99 think they’ve got it good (bad) now, just wait 10 or 20 more years until their bills really come due. Of course by then, the 1% likely won’t be doing so well either, but there’s the hope that each and every one of them (us/me) can sell before the deluge.”

What’s Gross getting at? The liabilities tied to the baby boomers — health care, private pensions, Social Security and “the unestimable costs of global warming,” he states.

It’s really just a numbers game, or as Gross puts it: “Demography rules.”

“If financial-market observers seem aghast at current Greek or Puerto Rican debt traps, they would surely take a double dose of Xanax when confronted with this: Fact – the U.S. government has current outstanding debt of approximately $16 trillion or close to 100% GDP,” he writes.

Citing research by Mary Meeker and others, he also points out that the present value of Medicaid’s commitments is $35 trillion, Medicare’s is $23 trillion, and Social Security’s is $8 trillion. These promised services bring the bill to $66 trillion, or 400% of GDP.

“We are broke and don’t even know it … we are having our cake, eating it at the same time and believing that a new cellphone app will be invented in the near future to magically deliver more of the same,” Gross says. “Not gonna happen, folks.”

What to Do

Some politicians advocate reducing the growth rate of current government debt.

But that “does little to help what in essence is a demographic not a financial problem: too few millennials to take care of too many boomers,” he points out.

As other analysts have highlighted in their research, the ratio of retirees to workers – the so-called dependency ratio – is soaring from .25 retirees per worker to .35 retirees per worker over roughly the next decade.

“There’s your problem, and neither privatization nor any goodly number of government bonds deposited in the Social Security ‘lock box’ can solve it,” Gross stresses.

As for the investment implications of the gloomy situation he describes, there are a few lessons to take to heart.

If most of the developing world is younger demographically (like India), then developed nations “could and should transfer an increasing percentage of their financial assets to emerging markets to help foot the demographic bills back home,” he explains.

In the long term, Gross says investors should “think about increasing your asset allocation to the developing world.”

Regarding fixed income, higher wages for today’s millenials may result from a shortage of health care workers. Thus, investors “should go long inflation and short fixed coupons. U.S. 10-year TIPS at 80 basis points seem like a good hedge in that regard,” Gross states.

Extrapolating these trends into specific equity sectors, he adds, means “health care should thrive, while liability handcuffed financial corporations such as insurance companies as well as the bonds of underfunded cities and states such as Chicago and Illinois, should not.”

The U.S., Gross notes, is not alone. Other countries, such as the United Kingdom, “have similar burdens,” he points out.

“In general, it seems demographically commonsensical that boomers have in part been responsible for asset appreciation during the heyday of their productive years, and that now, drip by drip, year by year, they will need to sell those assets to someone or some country in order to pay their own bills,” Gross explains.

His main conclusion: Asset returns will “be lower than historical norms, especially because interest rates are close to 0% in developed countries.”

And though Gross admits that demographic realities “may not rule absolutely,” they are poised to “dominate investment markets and returns for the next few decades until the Boomer phenomena fades away. The 1% – in addition to the 99 – will need extra doses of Xanax, or additional slices of cake, to cope in the next few decades.”

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