November 8, 2011
Gross said he would not invest in Europe -- European banks in particular – given the interconnected nature of sovereign debt and financial institutions and the potential for cascading risk. Growth will be the ultimate solution to Europe’s crisis, he said, and that will require an infusion of private capital. He doesn’t expect that to happen in the near term; China, he said, won’t get significantly involved unless it can see growth prospects.
Sonders expects better returns from equities. She noted that bonds have outperformed stocks longer than for any previous continuous period and she there should be a “reversion to the mean.” “I'm not so sure now is the time to be giving up on equities in favor of Treasuries,” she said.
“We have the potential to be pleasantly surprised on the equity side,” Sonders said, “but it is not going to come in any kind of smooth, steady line.” Investors should expect shorter business and market cycles, accompanied by a “semi-perpetual” increase in market volatility, she said.
Sonders said US equities could achieve low double-digit returns, despite growth of only 2%, provided that there is relatively low inflation to offset the sluggish growth.
Corporations have increased their share of GDP from approximately 8% to 13% over the last several years, she said, while labor costs have decreased from 66% to 61% of GDP. That has elevated corporate profits and buoyed market prices, but Sonders said those trends may be ending. Rising pricing and wage pressures will inhibit consumer spending, which Sonders said will prevent overall growth.
Explaining the poor performance of the Total Return fund
In February, Gross, who manages PIMCO’s Total Return fund, bet that interest rates would increase and took a short position in Treasury bonds. He was wrong, and the resulting performance of his fund was among the worst among its peers.
Gross explained that he did not foresee several adverse events, such as the debt-ceiling crisis and the deterioration in Europe. That caused a flight to safety, pushing up prices on Treasury bonds. “It happened so quickly,” he said, “I suppose it was quite difficult to adjust despite the fact that Treasuries were being offered almost every other week by old Uncle Sam.”
A problem with Gross’ explanation is that the two events he cited – the debt-ceiling impasse and the sovereign debt crises – did not escalate until the summer. But 10-year rates declined steadily beginning in February, and Gross did not explain his actions prior to August.
Gross pessimism
Over the short term, Gross said political impediments to growth will be daunting. “Both parties are clueless,” he said. Jobs are the near-term problem, he said, but the Obama administration has been “very ginger” in its policy recommendations. Republican suggestions to prioritize balancing the budget have similarly “avoided the critical question of how to create jobs,” he said.
Gross sounded his most pessimistic note when asked – hypothetically – how he would advise the Fed on its course of monetary policy. He said he would caution them about the destructive effects of commodity price inflation and negative real interest rates. But his sternest warning was with regard to financial repression and the disincentive it creates to save. Robust saving, he said, is “inherently important for the future of capitalism itself.”
Capitalism, Gross said, is indeed at risk. It depends on growing consumption, which he said has been fueled largely by leverage. Now capitalism is threatened by demographics, he said. It’s not just an aging but the potential for a shrinking population that poses risks for the global economy. Gross said he fears that the world’s population may decline at some point and “the common-sensical conclusion is that consumption moves in the same direction.”
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