"Financial systems are unstable with excessive risk-taking," warns PIMCO's now solo guru Bill Gross, telling Bloomberg TV's Stephanie Ruhle that in a "Soros reflexivity… Once you get the levered system going, it hardly knows when and where to stop." Credit, as we have noted, has been relatively more stable (though less positive on the the way up) Gross notes and "the way to get rich in the past was to borrow money and to lever [up]," but Gross explains that now, "assets are artificially priced… from this point forward, double-digit returns, getting rich on leverage, no. You better look elsewhere for – for your profits," and not Asia. China is "the mystery meat" of emerging market countries, Gross cautions, "nobody knows what’s there and there’s a little bit of baloney."
- *CHINA `MYSTERY MEAT' OF EMERGING MARKETS
- *ERA OF GETTING RICH QUICKLY IS OVER
- *ERA OF GETTING RICH SLOWLY IS ALSO OVER
- *INVESTORS SHOULD PREPARE FOR MORE VOLATILITY
ERIK SCHATZKER: I think we’ve got to start in the most obvious of places. Why are risk assets correcting? What in your opinion is behind the sell off?
BILL GROSS: Well risk assets, financial systems are unstable with excessive risk taking on one hand and low returns on the other, which in turn encourages more risk taking. It’s sort of like Soros’ reflexivity. Once you get the levered system going, it hardly knows when and where to stop. And so that’s what we’re seeing. We have a highly levered global financial system with hedged positions that are moving back and forth based on emerging market countries and their growth rates or expected growth rates. And when those change, then positions change. And as levered positions change, you’ve got a lot of volatility and reflexivity, as Mr. Soros would have said.
STEPHANIE RUHLE: Why aren’t we seeing that kind of volatility in the credit markets? Yesterday Hyundai did an investment grade deal and it blew out, while I look at equities in emerging markets and they’re suffering. Why is everyone still piling into credit?
GROSS: Well credit is higher up on the stability hierarchy I suppose, Stephanie. It – it usually is thought of as a flight to quality, not necessarily corporate bonds or high-yield bonds but treasury bonds. And when investors want to park money in a supposedly safe haven, and we know that bonds aren’t necessarily safe all the time, they weren’t in 2013, but that’s where money goes. Money comes back to the center so to speak of the global financial network. And the center at the moment are one, two, three developed countries. That certainly includes the United States. And so we see treasuries being bought, treasury rates coming down under the assumption that the Federal Reserve will stay put for perhaps a long, long time.
SCHATZKER: Bill, what happens next? Would you call this just a bump in the road or have markets made a detour and we’re going to go down this new road for a while?
GROSS: Well I think we will for a while, Erik, meaning for a long, long time. We’ve talked about this with the new normal. The new normal really didn’t apply to the equity market last year, did it? Thirty percent was certainly not normal. But what we see going forward is a global marketplace and a global economy where growth is slow.
And to the extent that financial asset prices like stocks and other risk assets have anticipated that growth rate, that’s always a subjective judgement. And it was six to eight weeks ago. To the extent that that growth rate comes down, then risk assets become at risk and more volatility. So I think it’s all dependent upon a growth rate on the global economy. And certainly in the United States we saw some bad numbers over the past few days and we wonder whether or not that 3 percent growth rate in 2014 is for real.
So look at growth and look at inflation, by the way, for an indicator in terms of where the Fed goes. Because as we know, where the Fed goes, where quantitative easing goes and tapering and ultimately the policy rate, which is critical, where that goes is dependent upon not just growth but inflation. And so the inflation target numbers that we see close to 1 percent are clearly indicative of where bonds might rest and ultimately where stocks might go as well.
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SCHATZKER: Bill, is that to say that nothing else has yet gotten cheap enough to tempt you?
GROSS: Well there’s no doubt that emerging markets are getting cheaper. The problem is emerging markets have problems. Take examples such as Brazil and Turkey. These are countries with widening current account deficits. These are countries which by necessity in order to stabilize their currency have to raise interest rates and put their economy at risk in terms of slower growth. So the question becomes whether a 13 percent three-year rate in Brazil relative to a 10 percent policy rate is an attractive situation. We think it’s getting there.
Brazil is not going anywhere in terms of straight downhill. It’s a country on the move, so to speak, and an important emerging market country, but to a certain extent it’s a fair question as to whether prices have been adequately discounting the slower growth that I speak to. I think we’re beginning to get there. The last wild card, Erik, in terms of emerging market space obviously is China. Is it 6 percent? Is it 7 percent? Is it 5 percent? I call China the mystery meat of emerging market countries. Nobody knows what’s there and there’s a little bit of baloney, so we’re just going to have to wonder going forward through this year as to the potential problems in China and other emerging markets.
RUHLE: All right. Mystery meat is disgusting. I remember my high school cafeteria. Tell us what investors are doing in terms of inflows and outflows. They’ve gotten very spoiled in the last couple of years with all the central bank intervention. It’s been very cushy. So this week your phone is ringing and what are they saying?
GROSS: Well they’re saying we want safety in principal. This is a Will Rodgers idea, Stephanie, back in the ‘30s. Not so much concerned about the return on my money as the return of my money. What product does that represent in terms of that possibility? Something with a relatively short duration and something with relatively short credit risk or credit spreads. Unconstrained bond funds are one example at PIMCO that are garnering a lot of attention. I’ve been managing that recen
tly and it’s doing really well.
The total return fund is doing really well. It’s up 1.5 to 2 percent for the month with some good stability and prospects for inflows. So bonds are back. They’re not all the way back, and I doubt they’ll get all the way back to the point of 16, 18 months ago in which interest rates in the 10-year was at 1.65. But bonds have a – have a stable position in almost all portfolios if only for diversification. So unconstrained bond funds, lower duration bond funds, diversified income, equities at some point. At PIMCO, yes, we’re promoting equities as well, and so there’s a place for all of them.
One last point though. I think the era of getting rich quickly is over, and I think almost that the era of getting rich slowly is over too. And so investors should simply bring down their return estimations and prepare for a little bit of volatility going forward.
RUHLE: So nobody’s getting rich anymore?
GROSS: Well not many. The way to get rich in the past was to borrow money and to lever hedge funds and levered corporate situations in terms of buyouts, et cetera, et cetera, or to buy the stock market in 2013, which itself is a levered type of investment. Corporations borrow 40 to 50 percent of their balance sheet. They lever up and you can buy equities in a levered type of situation. So leverage over the past 20 to 30 years, Stephanie, has really produced this total return, high return type of investment market that investors have grown used to. Pension funds think 7, 8, 9 percent is what they should expect, which means 4 percent from bonds and 12 percent from stocks. Not going to happen because basically we’ve been priced into the market. Assets are artificially priced. And from this point forward, double-digit returns, getting rich on leverage, no. You better look elsewhere for – for your profits.
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