Pacific Investment Management Co.'s Bill Gross argues that if global central banks can convince investors that their policies can reproduce the “old” normal economy, then risk assets will have higher future returns.
“Presumably the trickle-down wealth effect of appreciating assets will then lead to respectable growth rates andd a reduction in unemployment worldwide,” Mr. Gross wrote in his monthly investment outlook posted on Pimco's website today. Central banks must lead through qualitative forward guidance, a shift from “quantitative guidance that focused on unemployment rate thresholds that now are about to be breached,” he wrote.
The U.S. unemployment rate dropped to 6.6% in January, close to the Federal Reserve's stated threshold for considering raising rates. The Federal Open Market Committee said in December it will now keep the benchmark federal funds rate around zero “well past the time” unemployment falls below 6.5 percent, especially if projected inflation continues to run below their 2% target.
If investors embrace central banks' qualitative guidance, then stocks, bonds and other “carry” sensitive assets would outperform cash, wrote Gross, manager of the world's biggest bond fund. “If, however, the longevity and effectiveness of that artificially low policy rate comes into question, then the center is at risk — it may not hold.”
The $236 billion Pimco Total Return Fund has gained 2.07% so far this year, beating 42% of peers. The fund last year lost investors 1.9 percent, the most since 1994, while falling behind 65% of peers.
Investors pulled a net $1.6 billion from the fund in February, the least since May, according to a statement e-mailed by Pimco Monday. Net redemptions have decreased this year from the fund, which lost its title as the world's largest mutual fund in October.
Traditional risk assets have reached record highs this year. The Standard & Poor's 500 index rose 4.3% in February, ending the month at a record even as the Fed cuts back on its $65 billion monthly bond purchases, forecast to end this year. The bond tapering combined with forward guidance support are “intended to keep the level of accommodation the same overall and to push the economy forward,” former Fed Chairman Ben S. Bernanke told reporters on Dec. 18.
Since lowering the benchmark interest rate to near zero in December 2008, Fed officials have relied on bond buying and forward guidance about their plans to try to spur growth.
Asset prices “are dependent on investors' expectations and the confidence in policymakers and the effectiveness of their policies,” Mr. Gross wrote. Central banks “must have credibility,” he wrote, “or else the entire array of asset prices at the extremities is at risk.”
Carry trades “in numerous forms should be profitable” in 2014, Mr. Gross wrote. He recommends yield curve and investment-grade credit spreads based on a 2% growth rate in the U.S.
The U.S. gross domestic product is forecast to grow 2.9% this year, the most since before the financial crisis got under way in 2007, according to a forecast of economists in a Bloomberg News survey.
Investors should be mindful of longer-term consequences, Mr. Gross said.
“As quantitative easing ends in the U.S., liquidity in corporate bonds will be challenged,” Mr. Gross wrote. “If inflation begins to appear as a result of five years of artificially low policy rates worldwide, then assets may indeed be mispriced.”
Inflation in the U.S. continues to trail the Fed's target. A report yesterday showed the fed's preferred inflation measure, the personal consumption expenditure index, rose 1.2% in January from a year ago, below the central bank's 2% target.
“When credit is priced such that carry can no longer be profitable, or at least grow profits, at an acceptable amount of leverage/risk, then the system will stall or perhaps even tip,” Mr. Gross wrote.