Bill Gross’s monthly investment outlook is invariably worth reading, and this month is no exception. His writing is engaging as well as insightful, and as the overseer of $2 trillion in assets he’s worthwhile listening to. It turns out that like me, Bill has re-examined the Fed’s interest rate forecasts following the non-taper last month. He’s acknowledged the extremely gradual normalization of policy rates embedded in that forecast. Quantitative Easing grows the Fed’s balance sheet at $1 trillion a year, and as limitless as their appetite for bonds appears even this largesse must in due course end.
Bill elegantly makes the case for an extended period of low rates and therefore low returns on bonds, and links this to the deleveraging that took place following World War II. It was accompanied by “financial repression”, which is to say that savers received the short end of the stick compared to borrowers. He almost echoes my book, Bonds Are Not Forever, in making this point.
So now the question for the investor is this. In one corner you have the Fed’s $3.5 trillion balance sheet which is still growing. In the other you have Pimco’s $2 trillion collection of bond portfolios. The Fed is a non-commercial buyer unburdened by the need to demonstrate value added. As such they readily buy bonds at yields that are lower than private market demand alone would put them. Pimco has little choice but to hunt around for values in a market with fewer than it might otherwise have. They are in a real sense competing with one another, fighting it out for yield although the Fed has some unfair advantages in this contest.
The Bond King is hardly likely to throw in the towel on an entire asset class at this stage of the game. But for the rest of us, free of the commercial obligation to persist in investing in a market where yields offer scant return and no compensation for risk, we really can dial down our exposure to an asset class widely acknowledged to be expensive. Less bonds, more equities but importantly more cash too. You probably won’t hear Bill Gross make that recommendation, but his letter could just as easily have led to that conclusion.