What's in store for financial markets for the next few years? Ask Bill Gross, Managing Director at PIMCO, and he'll tell you that we're in store for
slow economic growth, high unemployment, and accelerating inflation.
In this month's Wealth IQ Report, we examine Gross' "New Normal", and how it may affect everyone's portfolios.
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Darren Whissen
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The New Normal
For the past year or so, Bill Gross, Managing Director at PIMCO, has been lecturing and writing about "The New Normal", a relatively new theory about the future of investing. According to Gross, nearly 50 years of economic prosperity has ended, and investors must prepare themselves for a long-period of lower-than-average returns.
According to Gross, the global economic boom started with the fall of the gold standard in 1971. Central banks began printing money, which in turn inspired new, "creative" financial instruments. "The combination of easy check-writing for central bankers and securitization made money cheap to the public," he recently said.
The boom reached its apex in the early ‘90s with the Great Moderation - a period of relatively low volatility and high returns, with inflation kept in check. Unfortunately, financial leverage grew unchecked and consumption grew until the bubble finally recently burst, leading to the end of the Great Moderation.
Of course, regulators have been piecing together solutions, including the TARP, TALF, PPIP, stimulus spending, and quantitative easing. These programs, however, will not avert what Gross calls the "New Normal" - slow economic growth, high unemployment, and accelerating inflation.
"The New Normal will be an inherent part of our economy for years to come," he said. Gross offered specific forecasts - economic growth of 1-2%, unemployment of 7-8%, and inflation kicking in over the next three to five years.
The New Normal replaces the previous paradigm, which Gross described as the "Child of the Bull Market." Under that paradigm, investors could rely on historically respectable rates of return, and whenever returns lagged they would reliably revert to the mean.
In the New Normal, Gross said things will not bounce back. "Growth will be stunted and subdued, and this will have a big impact on corporate profits" that could last ten years, he said.
Gross outlined seven rules for investing in the New Normal:
- "Buy and hold" with strategic rebalancing is dead. A 60/40 allocation was how you got rich in the past, but past results are now irrelevant.
- "Get used to your 301(k)," Gross said. Retirement accounts will not rebound to previous levels, as corporate growth rates and profit margins are at risk.
- Companies like Coca Cola and Proctor and Gamble, with large consumer franchises and the power to pass on price increases, are best positioned for this economy. Gross expects these companies to earn 6-8%, which he said was comparable to high-quality corporate bonds.
- Gross advised investors to look at what the government is buying and buy it first, and then look for the exit.
- One day, the dollar will lose its reserve status. Investors should diversify internationally more aggressively than in the past.
- Russia was a good bet when oil prices were high, and but investors should look at Brazil, India, and China - the BRIC economies minus the "R."
- Prepare for up to $3 trillion of gross government debt issuance in the next year. Debt is now 60% of GDP and will go to 100% in four years, and this will jeopardize the credit rating of US Treasury debt.
The last point concerns Gross the most. His fears extend beyond current budget deficits, and are more focused on the liabilities imposed by Social Security, Medicare, and Medicaid, to which he collectively attaches a $40 trillion price tag. Gross offers bond investors the most conservative advice he can - "confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable."
Don't plan on the New Normal era ending soon. "There won't be an end, just a different kind of world that we all have to get used to," Gross said.
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Disclosures
A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The value of an investment in debt securities will change as interest rates fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. Investments in high-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income.
The opinions in the preceding commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole.
This material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict performance of any investment. Investing involves risk, including possible loss of principal. Investors should consult with a financial advisor prior to making an investment decision.
Diversification does not guarantee a profit or protect against loss in a declining market.
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