By Bill Gross, CEO of PIMCO
- Once interest rates inch close to zero and discounted future cash flows are elevated in price, it’s difficult to generate much more return if economic growth doesn’t follow.
- Equity markets should be dominated by dividend yields and the return of capital via share buybacks, as opposed to growth.
- In fixed income assets, we suggest that portfolios should avoid longer dated issues where inflation premiums dominate performance.
?Ranking right up there with the myths about Santa Claus and the tooth fairy is the legend that pennies fall from heaven. This can’t be true, a priori, because God wouldn’t save pennies – nobody does! I know this for a fact because every weekend when Sue and I walk the neighborhood there is a fresh supply just waiting to be picked up on the blacktop. Here a penny, there a penny, everywhere a penny penny. Perhaps, I figure, it rained copper last night instead of H2O but no, they’re just on the street, lying there like a bunch of cigarette butts that someone obviously didn’t want to bother with. I will. As a matter of fact Sue and I compete for them. “Just think,” she said after beating me to the first on a three penny walk the other day, “there might be twenty or thirty thousand of these just lying around the street in this country right now. Think of all the good luck someone could be having.” And that of course is why someone should believe in pennies instead of the tooth fairy. They bring good luck: more than horseshoes, four-leaf clovers, or even betting on birthdates when you’re playing Lotto. Very, very lucky!
?There’s a theory that your luck depends on whether the penny is found heads or tails up. I’ve never been able to actually correlate that statistically. The competition is so fierce between Sue and I that the position of the penny goes unobserved as we push each other out of the way to be the official finder and therefore dispenser of the day’s good luck. When Sue gets there first she rather smugly hands the penny to me for safe keeping – her shorts having no pockets and all. I accept it reluctantly, all the while scouring the area for what might have been a “shower” of copperheads from some nonbeliever the night before.
This brings up an interesting question. If someone throws away a penny, is it bad luck? I’m not sure but I’m not risking it in any case. Those “Give a Penny, Take a Penny” containers near your local merchant’s cash register should be totally avoided. Giving a penny comes so close to throwing away a penny on the street that it ranks right up there with black cats, cracked mirrors and walking under ladders. In addition to pennies, I have advice on nickels, dimes and quarters that you might find lying along the road. Don’t touch ‘em. First and foremost, they don’t bring you any luck, and second of all they have billions of germs all over them. I’ve never been keen on cooties in any form or fashion. I might risk it for pennies, but I’m not about to pick up quarters no matter how profitable. Besides, how could any of you think that silver coated coins would be lying in the street in the first place? According to the efficient market theory, someone must already have picked them up. Find and savepennies. Very…very lucky!
Speaking of luck, the investment question du jour should be “can you solve a debt crisis with more debt?” Penny or no penny. Policymakers have been striving to answer it in the affirmative ever since Lehman 2008 with an assorted array of bazookas and popguns: 0% interest rates, sequential QEs with a twist, and of course now the EU grand plan with its various initiatives involving debt write-offs for Greece, bank recapitalizations for Euroland depositories and the leveraging of their rather unique “EFSF” which requires 17 separate votes each and every time an amendment is required. What a way to run a railroad. Still, investors hold to the premise that once a grand plan is in place in Euroland and for as long as the U.S., U.K. and Japan can play scrabble with the 10-point “Q” letter, then the markets are their oyster. Not being one to cast pearls before swine or little Euroland PIGS for that matter, I would tentatively agree with one huge qualifier:
As long as these policies generate growth.
Growth is the elixir that seems to make every ache, pain or serious ailment go away. Sovereign debt too high? Just grow your way out of it. Unemployment rates hitting historical peaks? Growth produces jobs. Stock markets depressed? Nothing a lot of growth wouldn’t cure. But growth is the commodity that the world is short of at the moment, as shown in Chart 1. No country has enough of it – not even China – and many of the developed countries (specifically in Euroland) seem to be shrinking into recession.
The situation, of course, is compounded now by high debt levels and government spending that always used to restart capitalism’s private engine. However, as economists Rogoff & Reinhart have shown in their historic text,This Time Is Different, sovereign debt at 80-90% of GDP acts as a barrier to growth. Because debt service and interest rate spreads start to rise at these debt levels, a greater and greater percentage of a nation’s output must necessarily be diverted to creditors who in turn become leery of reinvesting in a slowing economy. The virtuous circle becomes vicious in its reflexive counter reaction, spiraling into a debt/liquidity trap á la Japan’s lost decades if not stopped in time.
Halting the downward maelstrom is what current monetary policy is attempting to accomplish. With fiscal policy in most developed countries incredibly restrictive instead of stimulative, central banks have assumed the helm on their own – but it has been a long and relatively futile watch. Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill, for that matter. If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more