Bill Gross of Janus Capital spoke with Bloomberg’s Tom Keene about the state of the global economy.
Gross said China’s stock markets are likely to drop 5-6% on Friday: “Based upon the ETF in the United States, China is predicted to be down 5 percent or 6 percent…But China is an artificial market. All global markets are artificially based. And to the extent that we have a catharsis, I think, depends upon central banks basically giving up in terms of what they do. I don’t think that’s going to happen.”
When asked whether the market turmoil will cause Chair Yellen to say the rate hike is done, Gross said: “I don’t think she’ll say that. They’ve been on this track of raising interest rates for so long that she’s not going to come out with one or done. She may come out there — someone may come out — Fischer perhaps — will come out and acknowledge the fact that global markets and that global financial conditions are an important consideration in terms of future policy. But I don’t think they’re going to divulge that they are not raising interest rates for times as Stan Fischer said a few days ago.”
Gross said Central Banks have replaced homeowners as too levered: “Home owners are being replaced by central banks and central banks are writing endless checks of trillions of dollars and supporting stock markets and ultimately you can make the argument that they don’t run out of cash.”
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Bill Gross: Central Banks Replaced Homeowners as Too Levered
Bill Gross: China Stocks Will Probably Drop 5%-6% Friday
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TOM KEENE: Bill, good morning to you, thrilled to speak to you tomorrow on the jobs report. Let’s talk about the more urgent matters of this market.
First of all, Bill, China is the topic.
Is this about China and their stock market?
Or is there more going on on this January afternoon?
Bill Gross: Yes, it is about China specifically, Tom. But there’s a lot more going on and we’ve talked about it in past months.
The global economy is still highly levered and central banks are artificially elevating prices and keeping interest rates low.
Let me tell you this story from last night. My wife and I saw “The Big Short.” And afterwards, she said she understood exactly what went on in terms of subprimes and homeowners not being able to pay their bills and how it all collapsed.
And I said, “Well, there is a similarity to today’s market in that basically the same thing is going on except for homeowners are being replaced by central banks.”
And central banks are writing endless checks of trillions of dollars and supporting stock markets and ultimately you can make the argument that they don’t run out of cash. And I guess you could —
Bill Gross: — produces distortions in the global economy that we’re seeing now with oil and other commodity prices.
KEENE: Yes, David Guro (ph) mentioning the Dow down 404 points, David. Bill Gross as usual driving the market lower.
Bill, in that movie, there’s a scene at the end where the gentleman is on the deck overlooking Central Park and he has got to make the momentous decision to get in and out of the market. What are you actually doing within the first three or four trading days of this January?
Bill Gross: Well, we are trying to keep and to buy safe investments, Tom. Basically to my way of thinking, because there’s so much volatility, what you want to do is focus on Treasuries and, yes, we know Treasuries are doing well and have done well over the past few days and the past few weeks.
But you want to focus individually, I think, on some closed-in funds that are Treasury-related; the Janus Fund owns a stock called BBN, which is BlackRock Built America (ph), which is half-Treasury guaranteed and yields about 7.5 percent. So we’re doing things that reserve capital and still provide some type of return for shareholders.
KEENE: But Bill, this morning, Steve Major HSBC with us outlier call of a dramatically lower yield on the 10-year, reaffirmed that call and said it may happen sooner than he even thought.
Are you positioned for full faith and credit debt, whether it’s Germany, whether it’s the United States, to drive lower, given a global slowdown?
Bill Gross: Yes, I’d say we’re basically flat there, Tom. We have benefited over the past several weeks in terms of being long duration. We have had some optionality, so to speak, coming to the market over the past few days and so now we are basically flat duration.
So if tonight, there’s a big surprise in terms of the CNY and the Chinese market and Treasuries rally, we don’t benefit overnight. But I would think that Treasuries are a good investment for the next several weeks while we wait out this particular episode.
KEENE: One think I’ve noticed, Bill, was the correlations that have become a new year in January particularly seeing as Julie Heine (ph) had mentioned, copper dropping down today and gold moving higher. There seems to be a new correlate of mix in the market.
Do you agree with that assessment?
Bill Gross: Yes, I think so. And there’s a specific correlation — many people don’t know it — to oil and to commodities, but oil specifically. In terms of foreign currencies, many of the emerging market countries, some of which aren’t really oil exporters, Mexico being one, you know, they’re rather neutral in that regard, are affected by the price of oil as it goes down and so these correlations reflect, I think, Tom, an interlinking basically of global financial markets and positions that — of financiers and investment managers and hedge fund managers have on in terms of relatively levered bets.
And when one goes one way, basically they have to hedge in another direction and that’s why you see such volatility in commodities, oil, currencies and in stock prices as hedge managers are basically trying to get even in terms of their books.
It’s a highly levered world and when something gets out of whack like the Chinese currency or in terms of the oil price, then you see these movements everywhere.
KEENE: Within a highly levered world, do you see any sense of an immediate catharsis to clear markets?
Or is the theme for early 2016 that we slog along with this rolling pain in search of an abrupt move to clear markets?
Bill Gross: Well, China announced this morning that they are going to let markets clear. They haven’t —
KEENE: What will we see tomorrow morning?
Bill, what will we see out of Australia and into China tomorrow?
They’re going to go longer than seven or 12 minutes.
What would you predict we will observe?
Bill Gross: Well, based upon the ETF in the United States, China is predicted to be down 5 percent or 6 percent. It depends upon whether the Chinese are good to their word in terms of letting markets clear. They haven’t. And to the extent that it goes down more than 5 percent or 6 percent, who knows?
But China is an artificial market. All global markets are artificially based. And to the extent that we have a catharsis, I think, depends upon central banks basically giving up in terms of what they do. I don’t think they’re — that’s going to happen.
Draghi is in it, whatever it takes. The U.S. Fed will stop raising interest rates if the see a problem. China will get back into the markets if they have a catharsis and the Japanese, of course, buy stocks and bonds like they are going out of style.
So it’s up to the central banks basically to save the day or prevent a catharsis. And I think they will. But ultimately, to my way of thinking, that’s not a good thing but it allows for zombie corporations and zombie production that we are now seeing in terms of the oil market.
KEENE: Just so you don’t call it zombie surveillance.
Bill Gross, with what you just stated, of the responsibility of central banks, given the market turmoil and if we see more tomorrow and after the jobs report, will there be a responsibility of Chair Yellen to say we’re one and done, that’s all we’re going to do with our rate rises?
Bill Gross: Well, I don’t think she’ll say that. They’ve been on this track of raising interest rates for so long that she’s not going to come out with one or done. She may come out there — someone may come out — Fischer perhaps — will come out and acknowledge the fact that global markets and that global financial conditions are an important consideration in terms of future policy.
But I don’t think they’re going to divulge that they are not raising interest rates for times as Stan Fischer said a few days ago.
KEENE: You know, I look here at the bond market, Bill, and you got to convince our less sophisticated viewers and listeners, the idea that they can be protected by being diversified or buying unconstrained in that.
There’s a real sweat out there that this is like ’98 or this is like — frame this within the history that you worked in at your previous employer and now at Janus.
Where are we in terms of level of crisis?
Bill Gross: Yes and that’s a great question and if you got a minute. I will go through it as quickly as I can.
KEENE: Please. No, take —
Bill Gross: — Basically ever since — ever since I began my career in the early ’70s and the Fed basically relaxed and was off the gold standard, it has been a function of a carried trade for investors, not just unlevered investors but levered investors and hedge funds.
In other words, they tried to capture carry, carry in the form of duration, meaning longer maturity bonds, carry in the form of credit spreads, meaning lower quality instruments, carry in the form of volatility, carry, carry, carry. And ultimately that produced substantial bull markets, not just in bond markets but equity markets as well.
They captured basically carry relative to overnight financing and to Treasury bills.
Now when interest rates are so low and, in some cases, negative, it sets up the situation in which carry is not positive but negative. And you see in terms of the inner correlations, you see a market — and this happened with hedge funds last year — where the returns for hedge funds and other levered investors are basically zero or negative because the carry has collapsed and there’s no carry to capture.
And so what we see on days like today, when markets go down and oil prices go down and currencies fluctuate is a negative carry in which investors start to lose money and that ultimately is what the financial markets have taken us from the early ’70s in terms of high carry to now lower or negative carry.
KEENE: Well, that was beautifully explained but it also suggests we have got to get to an idea where we get back to normal.
Do you suggest, as Lawrence Summers suggests, that we are not going to get back to the normal where carry works because we are within a new terminal value, and we’re within some form of secular stagnation?
I mean, is something that what we’ve seen the last 24 hours, is it something we need to get used to?
Bill Gross: Well, I have been saying that for years, not to preempt Larry Summers, who’s a smart guy and secular stagnation, as he’s suggested, was not even his original idea. But the new normal from the old PIMCO days, basically said the same thing, that growth will be low, that interest rates will be even lower and that we have to get used to a world of low returns.
Now we didn’t really see that, did we, because of quantitative easing and the dropping of interest rates over the past three or four years. It has taken a while for that to take place.
But yes, secular stagnation in terms of demography, secular stagnation in terms of low interest rates, secular stagnation in terms of technology, all of that is producing a situation in which growth is low, interest rates are low, stock prices are relatively high and returns suffer.
KEENE: Bill, I know we’re going to see you tomorrow morning after this important jobs report. Let me ask you one more quick question.
You told me to buy years ago the 1918 Inverted Jenny postage stamp.
Am I safe still holding onto it?
Bill Gross: Well, it doesn’t go up all the time, either. Recently it traded for $350,000. It was as high as $450,000-$500,000. So, yes, there can be a bear market in stamps as well.
KEENE: OK. Bill Gross, thank you for the wisdom and I look forward to speaking to you at 8:35 tomorrow morning.