Investor Letters: Bill Gross
Legendary bond investor Bill Gross just released his latest investment outlook on the PIMCO website. According to Gross, investors in their “cash foxholes” might want to look at buying utilities in the “New Normal.” Here are some notable excerpts from the piece:
My point is to recognize, and to hope that you recognize, that an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive…
Moving out on the risk asset spectrum has worked wonders since March of this year, but it comes with the risk of principal loss – failing to receive the return of your money. When viewed from 30,000 feet, there is even a systemic risk that new asset bubbles are in the formative stages – perhaps because of the .01%. Gold at $1,130 an ounce, global equity markets up 60-70% from their 2009 lows, a cascading dollar now 15% lower against a basket of global currencies just 12 months ago, oil at 80 bucks, mortgage rates at 4% thanks to a $1 trillion dollar credit card from the Fed; the list goes on. The legitimate question of the day is, “Is a 0% funds rate creating the next financial bubble, and if so, will the Fed and other central banks raise rates proactively – even in the face of double-digit unemployment?”
Gross thinks that the U.S. central bank will hold rates downs for some time in an attempt to reflate the economy. He said:
We will need another 12 months of 4-5% nominal GDP growth before Bernanke and company dare lift their heads out of the 0% foxhole – mini-bubbles or not…
…let me state the obvious, but often forgotten bold-face fact: The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until.
As usual, Gross offers advice to the investor. From the piece:
OK, so where does that leave you, the individual investor, the small saver who is paying the price of the .01%? Damned if you do, damned if you don’t. Do you buy the investment grade bond market with its average yield of 3.75% (less than 3% after upfront fees and annual expenses at most run-of-the-mill bond funds)? Do you buy high yield bonds at 8% and assume the risk of default bullets whizzing at you? Or 2% yielding stocks that have already appreciated 65% from the recent bottom, which according to some estimates are now well above their long-term PE average on a cyclically adjusted basis? Two suggestions. First, as emphasized in prior Investment Outlooks, the New Normal is likely to be a significantly lower-returning world. Diminished growth, deleveraging, and increased government involvement will temper profits and their eventual distribution to investors in the form of dividends and interest. As banks, auto companies and other corporate models become more regulated and therefore more like utilities and less like Boardwalk and Park Place, they will return less.
Which brings up the second point. If companies are going to move toward a utility model, why suffer the transformational revaluation risk of equities with such a low 2% dividend return? Granted, Warren Buffet went all-in with the Burlington Northern, but in doing so he admitted it was a 100-year bet with a modest potential return. Still, Warren had to do something with his money; the .01% was eating a hole in his pocket too. Let me tell you what I’m doing. I don’t have the long-term investment objectives of Berkshire Hathaway, so I’m sort of closer to an average investor in that regard. If that’s the case, I figure, why not just buy utilities if that’s what the future American capitalistic model is likely to resemble. Pricewise, they’re only halfway between their 2007 peaks and 2008 lows – 25% off the top, 25% from the bottom. Their growth in earnings should mimic the U.S. economy as they always have, and most importantly they yield 5-6% not .01%! In a low growth environment, it seems to me that a company’s stock should yield more than its less risky debt, and many utilities provide just that opportunity. Utilities and even quasi-utility telecommunication companies now yield between 5 and 6%, whereas their 10- and 30-year bond yield less and at a higher tax rate to you the investor.
You can read the entire investment outlook here.
Source:
“Anything but .01%”
Bill Gross
PIMCO, December 2009
