Bond fund manager Bill Gross has a message for all those investors and advisors hoping to reap investment gains this year: Don’t expect much, and be prepared for losses.
“At best [there’s] a ceiling on risk asset prices (stocks, high-yield bonds, private equity, real estate) and at worst, minus signs at year’s end…,” writes Gross in his latest Investment Outlook at Janus Capital, where he manages the Janus Global Unconstrained Bond Fund (JUCIX). “Worry for now about the return ‘of’ your money, not the return ‘on’ it.”
As of mid-afternoon Wednesday, the S&P 500 was up 2.45% year to date, and the iShares iBoxxx High Yield Corporate Bond ETF (HYG) was ahead 7.54%.
Underlying Gross’ bearishness is the slowdown in credit growth, which he writes is running at less than half the rate that prevailed since the beginning of this century – averaging 4% annual growth versus 9%.
“Credit is the oil that lubes the system, the straw that stirs the drink, and when the private system (not the central bank) fails to generate sufficient credit growth, then real economic growth stalls and even goes in reverse,” writes Gross.
It’s not as if there wasn’t a lot of credit in the system – Gross writes that credit and debt from households, businesses, government and finance-based sources now totals $62 trillion. It’s the fact that credit isn’t growing enough to fuel growth, according to Gross.
“A highly levered economic system is dependent on credit creation for its stability and longevity, and now it is growing suboptimally,” writes Gross.
He blames private banks, not central banks, for the lack of credit growth. Central banks “have lots and lots of money available but only if the private system – the economy’s real bankers — decide to use it and expand ‘credit.’ If banks don’t lend, either because of risk to them or an unwillingness of corporations and individuals to borrow money, then credit growth doesn’t increase,” writes Gross.
Gross likens the situation to the game of Monopoly, where the bank – the “private bank” – hands out $1,500 to each player at the start and $200 each time a player passes “go.” That $200 of credit creation never increases, so players who haven’t reserved enough cash or haven’t purchased enough houses or hotels – or the right ones – to collect rent from other players eventually go bankrupt. The game that targets asset accumulation and growth turns competitive, and only the strongest survive.
“The system” that generates just $200 per round trip per player is “not enough to keep real GDP at the same pace and to prevent some companies/households from going bankrupt,” writes Gross about Monopoly. The frequency that the money or credit turns over to purchase more houses and hotels slows.
In the real economy, that turnover is known as velocity and it usually increases when interest rates are near zero, but that’s not the case today, notes Gross. Despite near zero or negative rates on $10 trillion worth of government debt, “the contribution of velocity to GDP growth is coming to an end and may even be creating negative growth.
“Our credit-based financial system is sputtering and risk assets are reflecting that reality even if most players (including central banks) have little clue as to how the game is played.”
As always, Gross criticizes the Federal Reserve and its chair, Janet Yellen, this time for not believing in “Monopoly as the functional model for the modern-day financial system” but in the Taylor Rule (for interest rate forecasting) and Phillips Curve (to forecast the tradeoff between inflation and employment) instead. They “warn about future inflation as we approach ‘full employment.’ They worship false idols.”
Gross doesn’t offer much in the way of a solution to the economic and market doldrums he’s forecasting except to say that “until governments can spend money and replace the animal spirits lacking the private sector, then the Monopoly board and meager credit growth shrinks as a future deflationary weapon.” And he cautions that investors shouldn’t count on such deficit spending anytime soon. “The fiscal side of our current system has been nonexistent.”
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