To say that bond fund manager Bill Gross is negative on the financial markets would be a major understatement. In his latest monthly investment outlook and simulcast interview on Bloomberg radio and television, the lead portfolio manager of the Janus Global Unconstrained Bond strategy warned investors about a future of low returns and high risk due to major changes in the global economy.
“For over 40 years, asset returns and alpha generation from penthouse investment managers have been materially aided by declines in interest rates, trade globalization and an enormous expansion of credit, that is debt,” Gross wrote in his latest outlook.
Over that time period, the Barclays Capital U.S. Aggregate Index gained close to 7.5% annually, while stocks earned an additional 3%. It was a “remarkable” performance that “cannot be repeated” because interest rates are near zero or negative in many developed markets and stocks historically earn about 3% more in “equity premium,” wrote Gross. “Those trends are coming to an end if only because in some cases they can go no further.”
Bond yields, for example, “would have to drop to -17%” in order to repeat the 7.5% gain over the past 40 years, according to Gross.
“A repeat performance is not only unlikely, it is impossible, unless you are a friend of Elon Musk and you’ve got the gumption to blast off to Mars. Planet Earth does not offer such opportunities.” Musk, the CEO of electric carmaker Tesla Motors, is also the founder and CEO of SpaceX, which hopes to transport humans to Mars by 2025.
Given his outlook, Gross suggests that investors consider holding more cash and lower the duration of this bond portfolio, ultimately selling some bonds. “At some point … an investor will be better served by selling as opposed to buying,” he told Bloomberg, noting that we’re not at that point yet. He essentially affirmed much of what he wrote in his February market outlook, where he advised investors to stay away from “high-risk markets” and remain safe with “plain vanilla assets.”
Gross expects lower rates in the U.S. will continue longer than many had expected as a result of Friday’s disappointing employment report. Like many fund managers and economists, Gross said the report, showing payrolls rising just 38,000 and the jobless rate falling to 4.7% from 5%, largely because more people left the job market, will delay a Fed rate hike. The payroll number “was so low they’ve got to take a pause,” Gross told Bloomberg.
He iterated his view that the U.S. government, as well as other governments, need to spend more money, especially on infrastructure to boost economic growth. “Government needs to get in there and start writing checks as opposed to the private sector, which is not.”
Given that governments are not doing that and his view that bond and stock market returns over the past 40 years won’t be repeated anytime soon, what is Gross suggesting that investors do now? First, he lays out the risk inherent in these strategies:
- Extending bond maturities. With 10-year Treasuries having a 125-point “carry” over cash, “maturity extension … is hardly worth the risk.”
- Reducing credit quality. Reaching for credit “carry,” such as holding a 5-year investment grade corporate bond over the next 12 months, offers an additional “mere 25 basis points” in yield.
- Selling volatility. “Any investment longer or less creditworthy than a 90-day Treasury Bill sells volatility whether a portfolio manager realizes it or not …There is little to be gained by selling outright volatility or other forms in duration and credit space.”
- Liquidity. There is little to be gained owning less liquid investments because spreads have tightened, not only between the yields of newly issued “on the run” Treasury bonds and bonds already trading in the market, but also between the discounts and NAV of closed-end funds, according to Gross.
“Returns will be low, risk will be high and at some point the ‘intelligent investor’ must decide that we are in a new era with conditions that demand a different approach,” wrote Gross. It could include buying “negative duration … shorting corporate credit, buying instead of selling volatility [and] staying liquid with large amounts of cash.” According to Gross, “These are all potential ‘negative’ carry positions that at some point may capture capital gains or at minimum preserve principal.”
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