Earlier this week, Janus Capital Group’s Bill Gross shared his Monthly Investment Outlook with the financial crowd. After a
short dissertation on how to explain sex to children, he went into “equally important questions in today's economy and financial
markets.” Seeking to explicate the current situation, Gross asked and answered five questions about the U.S. economy.
The Big 5
1. When does our credit-based financial system sputter/break down?
When the risk posed by investable assets is too high in relation to the return, Gross explained. “Not immediately, but at the
margin, low/negative yielding credit is exchanged for figurative and sometimes literal gold or cash in a mattress. When it does,
the system delevers as cash at the core, or real assets like gold at the risk exterior, become the more desirable assets,” he
added.
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Marks Are Sounding The Alarm
“Central banks can create bank reserves, but banks are not necessarily obliged to lend it if there is too much risk for too
little return. The secular fertilization of credit creation may cease to work its wonders at the zero bound, if such conditions
persist.”
2. Can capitalism function efficiently at the zero bound?
For Gross, the answer is "no." While it is true that low interest rates may help boost asset prices, they also wipe out reserves
and liability based business models. This means the economy is stripped of its ability to pay for future liabilities; and central
banks seem to be overlooking this. Moreover, the investor continued, if this situation lingers for too long, the real economy
starts to feel the effects, since “expected income fails to materialize and investment spending stagnates.”
3. Can $180 billion of monthly quantitative easing by the ECB, BOJ, and the BOE keep on going? How might it
end?
While this QE can go on, it will eventually lead to a shrinkage in the supply of high quality assets, which, in turn, leads to
considerable technical problems like repo and negative interest rates.
“Remarkably, central banks rebate almost all interest payments to their respective treasuries, creating a situation of money for
nothing — issuing debt for free. Central bank "promises" of eventually selling the debt back into the private market are just that
— promises/promises that can never be kept. The ultimate end for QE is a maturity extension or perpetual rolling of debt. The Fed
is doing that now but the BOJ will be the petri dish example for others to follow, if/when they extend maturities to perhaps 50
years,” Gross expounded.
4. When will investors know if current global monetary policies will succeed?
The largest portion of assets is allocated to growth (at least nominal) and inflation. And, nominal growth is key to any
(collective or individual) economy, as it allows it service its debts with surging income, assigning a part to interest
expenditures and the remaining portion to “theoretical or practical principal repayment via a sinking fund. Without the latter, a
credit-based economy ultimately devolves into Ponzi finance, and at some point implodes. Watch nominal GDP growth. In the U.S. 4
percent is necessary, in Euroland 3–4 percent, in Japan 2–3 percent.”
5. What should an investor do?
In the current backdrop of elevated risks and low returns, Gross would recommend to accept the latter, while reducing the
former. However, one must put his/her money down somewhere. But where?
“Negative returns and principal losses in many asset categories are increasingly possible unless nominal growth rates reach
acceptable levels,” he added. And, since he doesn’t like bonds, private equity and most stocks, he would advise investing in
tangible assets like land, gold or even equipment. However, individual investors cannot access these assets easily, for wealth has
been "financialized."
“How about Janus Global Unconstrained strategies? Much of my money is there,” Gross concluded.
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Disclosure: Javier Hasse holds no interest in any of the securities or entities mentioned above.
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