the world’s biggest bond fund for Pimco.
The actions of the Fed, led by Chairman Ben Bernanke, 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,” he wrote in a commentary posted on Pimco’s
website Wednesday.
See Gross’s full commentary.
“Check writing in the trillions is not a bondholder’s friend; it is
in fact inflationary, and, if truth be told, somewhat of a Ponzi
scheme,” he said. While the U.S. has sometimes paid down its debt,
“there was always the assumption that as long as creditors could be
found to roll over existing loans – and buy new ones – the game
could keep going forever.”
The Fed is close to embarking on a new round of monetary stimulus
next week despite doubts among economists and some Fed decision
makers. Jon Hilsenrath discusses. Also, John W. Miller discusses
Europe's tougher line on trade with China, as the EU focuses on
China's process for bidding on contracts.
Two-year Treasury yields
/quotes/comstock/31*!ust2yr
(UST2YR 0.41, -.00, -0.96%) , which move inversely to
prices, fell to the lowest level on record -- 0.33% -- recently as
bond investors increasingly expected the Fed to announce a second
massive bond-purchase program after its meeting on Nov. 2-3.
Yields on 10-year notes
/quotes/comstock/31*!ust10y
(UST10Y 2.70, -0.03, -0.95%) fell to the lowest since
January 2009 and the dollar index
/quotes/comstock/11j!i:dxy0
(DXY 77.96, -0.19, -0.25%) , a measure of the U.S.
currency against a basket of major rivals, has dropped back to the
weakest levels of the year.
Going into next week’s elections, Gross said voters need to realize
that this Ponzi scheme is unusually “brazen” and has been brought
on by the government – of every political party – and its
citizens.
“It is not a Bernanke scheme, because this is his only alternative
and he shares no responsibility for its origin,” he said.
Such a plan “raises bond prices to create the illusion of high
annual returns, but ultimately it reaches a dead-end where those
prices can no longer go up,” Gross wrote. “Having arrived at its
destination, the market then offers near 0% returns and a picking
of the creditor’s pocket via inflation and negative real interest
rates.”
Deborah Levine is a MarketWatch reporter, based in New
York.
http://www.pimco.com/Pages/RunTurkeyRun.aspx
Investment Outlook
William H. Gross
| November 2010
Run Turkey, Run
- The Fed’s announcement of a renewed commitment to
Quantitative Easing has been well telegraphed and the market’s
reaction is likely to be subdued.
- 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.
- The Fed’s announcement 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.
They say a country gets the politicians it deserves or perhaps it
deserves the politicians it gets. Whatever the order, America is
next in line, and as we go to the polls in a few short days it’s
incumbent upon a sleepy and befuddled electorate to at least ask
ourselves, “What’s going on here?” Democrat or Republican, Elephant
or Donkey, nothing much ever seems to change. Each party has shown
it can add hundreds of billions of dollars to the national debt
with little to show for it or move our military from one country to
the next chasing phantoms instead of focusing on more serious
problems back home. This isn’t a choice between chocolate and
vanilla folks, it’s all rocky road: a few marshmallows to get you
excited before the election, but with a lot of nuts to ruin the
aftermath.
Each party’s campaign tactics remind me of airport terminals
pre-9/11 when solicitors only yards apart would compete for the
attention and dollars of travelers. “Save the Whales,” one would
demand, while the other would pose as its evil twin – “Eat Whale
Blubber,” the makeshift sign would read. It didn’t matter which
slogan grabbed
you, the end of the day’s results always
produced a pot of money for
them and the whales were neither
saved nor eaten. American politics resemble an airline terminal
with a huckster’s bowl waiting to be filled every two years.
And the paramount problem is not that we contribute so willingly or
even so cluelessly, but that there are only two bowls to choose
from. Thomas Friedman, the respected author of
The World Is
Flat, and a weekly
New York Times Op-Ed author, recently
suggested “ripping open this two-party duopoly and having it
challenged by a serious third party” unencumbered by special
interest megabucks. “We basically have two bankrupt parties,
bankrupting the country,” was the explicit sentiment of his
article, and I couldn’t agree more – whales or no whales. Was it
relevant in 2004 that John Kerry was or was not an admirable “swift
boat” commander? Will the absence of a mosque within several
hundred yards of Ground Zero solve our deficit crisis? Is Christine
O’Donnell really a witch? Did Meg Whitman employ an illegal maid?
Who cares! We are being conned, folks; Democrats and Republicans
alike. What have you really heard from either party that addresses
America’s future instead of its prurient overnight fascination with
scandal? Shame on them and of course, shame on us. We’re getting
what we deserve. Vote NO in November – no to both parties. Vote NO
to a two-party system that trades promises for dollars and hope for
power, and leaves the American people high and dry.
There’s another important day next week and it rather
coincidentally occurs on Wednesday – the day after Election Day –
when either the Donkeys or the Elephants will be celebrating a
return to power and the continuation of partisan bickering no
matter who is in charge. Wednesday is the day when the Fed will
announce a renewed commitment to Quantitative Easing – a polite
form disguise for “writing checks.” The market will be interested
in the amount (perhaps as much as an initial $500 billion) as well
as the targeted objective (perhaps a muddied version of “2%
inflation or bust!”). The announcement, however, has been well
telegraphed and the market’s reaction is likely to be subdued. More
important will be the answer to the long-term question of “will it
work?” and perhaps its associated twin “will it create a bond
market bubble?”
Whatever the conclusion, not only investors, but the American
people should recognize that Wednesday, even more than Tuesday,
represents a critical inflection point in determining our future
prosperity. Of course we’ve tried it before, most recently in the
aftermath of the Lehman crisis, during which the Fed wrote $1.5
trillion or so in “checks” to purchase Agency mortgages and a
smattering of Treasuries. It might seem a tad dramatic then, to
label QEII as “critical,” sort of like those airport hucksters, I
suppose, that sold whale blubber for a living. But two years ago,
there was the implicit assumption that the U.S. and its associated
G-7 economies needed just an espresso or perhaps an Adderall or two
to get back to normal. Normal just hasn’t happened yet, and
economic historians such as Kenneth Rogoff and Carmen Reinhart have
since alerted us that countries in the throes of delevering can
take
many, not
several, years to return to a steady
state.
The Fed’s second round of QE, therefore, more closely resembles an
attempted hypodermic straight to the economy’s heart than its mood
elevator counterpart of 2009. If QEII cannot reflate capital
markets, if it can’t produce 2% inflation and an assumed reduction
of unemployment rates back towards historical levels, then it will
be a long, painful slog back to prosperity. Perhaps, as a vocal
contingent suggests, our paper-based foundation of wealth deserves
to be buried, making a fresh start from admittedly lower levels.
The Fed, on Wednesday, however, will decide that it is better to
keep the patient on life support with an adrenaline injection and a
following morphine drip than to risk its demise and ultimate
rebirth in another form.
We at PIMCO join with Ben Bernanke in this diagnosis, but we will
tell you, as perhaps he cannot, that the outcome is by no means
certain.
We are, as even some Fed
Governors now publically admit, in a “liquidity trap,” where
interest rates or trillions in QEII asset purchases may not
stimulate borrowing or lending because consumer demand is
just not there. Escaping from a liquidity trap may be impossible,
much like light trapped in a black hole. Just ask
Japan. Ben Bernanke, however, will try – it is, to be honest, all
he can do. He can’t raise or lower taxes, he can’t direct a fiscal
thrust of infrastructure spending, he can’t change our educational
system, he can’t force the Chinese to revalue their currency – it
is all he can do, and as he proceeds, the dual questions of “will
it work” and “will it create a bond market bubble” will be
answered. We at PIMCO are not sure.
Still, while next Wednesday’s announcement will carry our qualified
endorsement, I must admit it may be similar to a Turkey looking
forward to a Thanksgiving Day celebration. Bondholders, while
immediate beneficiaries, will likely eventually be delivered on a
platter to more fortunate celebrants, be they financial asset
classes more adaptable to inflation such as stocks or commodities,
or perhaps the average American on Main Street who might benefit
from a hoped-for rise in job growth or simply a boost in nominal
wages, however deceptive the illusion.
Check writing in the trillions is not a bondholder’s
friend; it is in fact inflationary, and, if truth be told, somewhat
of a Ponzi scheme. Public debt, actually, has always had a
Ponzi-like characteristic. Granted, the U.S. has, at
times, paid down its national debt, but there was always the
assumption that as long as creditors could be found to roll over
existing loans – and buy new ones – the game could keep going
forever. Sovereign countries have always implicitly acknowledged
that the existing debt would never be paid off because they would
“
grow” their way out of the apparent predicament, allowing
future’s prosperity to continually pay for today’s finance.
Now, however, with growth in doubt, it seems that the Fed has taken
Charles Ponzi one step further. Instead of simply paying for
maturing debt with receipts from financial sector creditors –
banks, insurance companies, surplus reserve nations and investment
managers, to name the most significant – the Fed has joined the
party itself. Rather than orchestrating the game from on high, it
has jumped into the pond with the other swimmers. One and one-half
trillion in checks were written in 2009, and trillions more lie
ahead. The Fed, in effect, is telling the markets not to worry
about our fiscal deficits, it will be the buyer of first and
perhaps last resort. There is no need – as with Charles Ponzi – to
find an increasing amount of future gullibles, they will just write
the check themselves. I ask you: Has there ever been a Ponzi scheme
so brazen? There has not. This one is so unique that it requires a
new name. I call it a Sammy scheme, in honor of Uncle Sam and the
politicians (as well as its citizens) who have brought us to this
critical moment in time. It is not a Bernanke scheme, because this
is his only alternative and he shares no responsibility for its
origin. It is a Sammy scheme – you and I, and the politicians that
we elect every two years – deserve all the blame.
Still, as I’ve indicated, a Sammy scheme is temporarily, but not
ultimately, a bondholder’s friend. It raises bond prices to create
the illusion of high annual returns, but ultimately it reaches a
dead-end where those prices can no longer go up.
Having arrived at its destination, the market then
offers near 0% returns and a picking of the creditor’s pocket via
inflation and negative real interest rates. A similar fate, by the way, awaits stockholders,
although their ability to adjust somewhat to rising inflation
prevents such a startling conclusion. Last month I outlined the
case for low asset returns in almost
all categories, in part
due to the end of the 30-year bull market in interest rates, a
trend accentuated by QEII in which 2- and 3-year Treasury yields
approach the 0% bound. Anyone for 1.10% 5-year Treasuries? Well,
the Fed will buy them, but
then what, and how will PIMCO
tell the 500 billion investor dollars in the Total Return strategy
and our equally valued 750 billion dollars of other assets that the
Thanksgiving Day axe has finally arrived?
We will tell them this. Certain Turkeys
receive a Thanksgiving pardon or they just run faster than others!
We intend PIMCO to be one of the chosen gobblers. We
haven’t been around for 35+ years and not figured out a way to
avoid the November axe. We are a survivor and our clients are not
going to be Turkeys on a platter. You may not be strutting around
the barnyard as briskly as you used to – those near 10% annualized
yields in stocks and bonds are a thing of the past – but you’re
gonna be around next year, and then the next, and the next.
Interest rates may be rock bottom, but there are other ways – what
we call “safe spread” ways –to beat the axe without taking a lot of
risk: developing/emerging market debt with higher yields and
non-dollar denominations is one way; high quality global corporate
bonds are another. Even U.S. Agency mortgages yielding 200 basis
points more than those 1% Treasuries, qualify as “safe spreads.”
While our “safe spread” terminology offers no guarantees, it is
designed to let you sleep at night with less interest rate
volatility. The Fed wants to buy, so come on, Ben Bernanke, show us
your best and perhaps last moves on Wednesday next. You are doing
what you have to do, and it may or may not work.
But either way it 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.
If a country gets the politicians it deserves, then the same can be
said of an investor – you’re gonna get what you deserve. Vote No to
Republican and Democratic turkeys on Tuesday and Yes to PIMCO on
Wednesday. We hope to be your global investment authority for a new
era of “SAFE spread” with lower interest rate duration and price
risk, and still reasonably high potential returns. For us, and
hopefully you, Turkey Day may have to be postponed
indefinitely.
William H. Gross
Managing Director
