Will the Real Bill Gross Please Stand Up?
In his latest Investment Outlook, PIMCO’s Bill Gross wrote a scathing critique of the present state of American politics and cautioned investors on the outlook for the economy in anticipation of the Federal Reserve Bank’s second bout with quantitative easing, AKA QE 2.0. When Bill Gross speaks people listen and in this particular outlook, dubbed Run Turkey, Run, there are many points for investors, bloggers and analysts alike to take hold of. Considering how dense this particular piece is, it’s been very interesting to see the reaction to Gross’ words so far.
Many points within the outlook deserve attention, but I feel as though one particular point has been completely ignored altogether–and it’s an important one. Although Gross cautions everyone ahead of QE 2.0 he acknowledges that “it is not a Bernanke scheme” and it’s the Fed Charmain’s “best and last move” in this battle with a sluggish economy. There is an important underlying message to Gross’ analysis that gets lost altogether in the surrounding commentary. I will get to the specifics below, but let’s work our way there.
What many perceive to be “the” most important point from Gross is that he declared the Fed’s upcoming action “will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.” Coming from Gross, a man with the utmost credentials in navigating the bond market and who built his life’s work riding the bond bull with the wind at his back, his calling the top in bonds is a monumental event in and of itself. That being said, while his timing appears impeccable, once against the zero-bound, the bond bull had only so much more room to go.
We can (and should) applaud Gross for having stuck with bonds throughout last year while great thinkers and investors like Nassim Nicholas Taleb were saying that “every single human being” should be short Treasuries, but for Gross to make this declaration with generationally low interest rates that have little, if any wiggle room is not breaking any new ground. Gross proceeds to explain the Ponzi-esque nature at the essence of quantitative easing and facetiously coins the term “Sammy Scheme” to describe the maneuver. The Zero Hedgies of the world clearly love this type of explanation, as such talk alone is justification for buying that cave and stashing those cans of beans and the Rick Santelli’s love it for how it somehow sounds like an endorsement for spending cuts and fiscal austerity.
These people coopt the segments of Gross’ statement that fit their talking points in order to continue asserting the same baseless claims over and again. Just this morning, Santelli used Gross’ “ponzi” statement in order to push his austerity argument once again, but if he really cared to know anything about what Gross was trying to say he would need not look far. In his June outlook, Gross offered the following advice for policymakers to those preaching fiscal austerity:
In many cases therefore, it may not be possible for a country to escape a debt crisis by reducing deficits!” [emphasis Gross’] While conventional wisdom may hold that reducing spending will close a deficit gap, reality has consistently demonstrated that reducing spending ultimately increases deficits.
Again, the Santelli’s of the world would be very disappointed if they really understood what Gross was getting at here.
What is that larger point? Well I think it’s quite clear from Gross’ explanation, but his point is that the political process in America is so bankrupt (the process, not the country) at this point that Bernanke is left with no option but to do it alone. Politics has become so self-absorbed with elections and taking the steps necessary to shoot down opponents rather than building constructive debate about the real, and difficult issues that require immediate attention and action. And what would a Congress seriously committed to fixing this country do right now? They would do a real fiscal stimulus based around infrastructure projects that pay long-term dividends for the private sector.Although Gross didn’t outright say this, it’s pretty clear from the totality of his statements over the past few years.
In one of his bullet points preceding the narrative, Gross declares that: “We are in a “liquidity trap,” where interest rates or trillions in asset purchases may not stimulate borrowing or lending because consumer demand is just not there [emphasis mine]” and Bernanke is left with no choice because he alone “can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, [and] he can’t force the Chinese to revalue their currency.” We need some sort of demand stimulant from our government and this Congress (and certainly our next Congress) won’t even engage in a serious debate as to how to reach a consensus and accomplish that task. I only wish Bill Gross bluntly stated this fact rather than alluding to it.
What can we as investors do to adjust to this “new environment” that Gross describes? Well as he says, QE 2.0 is inflationary and not a bondholders friend. This action from the Fed shifts the allocation preference for portfolio managers from bonds to equities, because the bondholder’s primary enemy is inflation and this latest Fed action will if successful, push the economy back to its trend inflation rate. Even if it fails, this Fed action shifts the macroeconomic risk from deflationary to inflationary, thus leading to a serious allocation preference in favor of equities.