In the bond world, few names are as well respected as that of Bill Gross.
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He and his team of analysts at Pacific Investment Management (Pimco) run the country's largest bond fund -- and one of its most successful -- the (PTTAX) - Get PIMCO Total Return A Report Pimco Total Return fund, a $50 billion fund that's had a stellar 10.6% return so far this year.
The first fund manager to be named Morningstar's Manager of the Year twice (in 1998 and 2000), Gross oversees the management of nearly one-quarter trillion dollars in fixed-income investments for many of the top pension funds in the country.
Here, Gross gives TSC his take on inflation, the Fed; which bond sectors look the most attractive now; where he's investing his own money; and what he expects from both the stock and bond markets in the years to come.
TSC: How have you managed to return 10.6% in what's been an ugly 2001?
Gross: 2001 has been the "ugly duckling" year, hasn't it? But if I'm remembering my fairy tales correctly, didn't the ugly duckling eventually become a beautiful swan? Perhaps there's hope for 2002 after all.
How did we do it? By placing correct sectors bets as investors shifted from equities to bonds in their flight to quality. For quite some time we have been advising investors to avoid sectors like corporates, high-yield and emerging markets, and to stick to high-quality, high-yielding investments. But those sectors will have their day in the sun soon, perhaps as early as the beginning of the new year.
TSC: Has your strategy changed since Sept. 11? If so, how? Are these long-term or short-term adjustments?
Gross: Our strategy really hasn't changed. Before the tragedy and after, Pimco's economic outlook has been for a slower economy. The attacks only emphasized and hastened our beliefs for a slower economy and for a global recession. Our outlook, unfortunately, continues to be a gloomy one.
The attacks also amplified investors' continued flight to quality. Anytime you have a crisis, such as the events of Sept. 11, investors flee to the safest investment vehicles they can find, and those tend to be short-term Treasury notes and bills. And as a result, yields on the short-term securities were driven down to unsustainable levels -- so we made plans to sell the bulk of what we held. So Pimco has become a short-end seller and a long-end buyer.
TSC: Why do you think the Treasury decided to eliminate future sales of the 30-year Treasury bond? What should an investor buy now instead?
What the Treasury was trying to do was to lower the 30-year fixed-rate mortgage interest rates. The real way to stimulate this economy is to promote refinancings, which will allow the American homeowner to move down in coupon and to lower their interest payments.
Greenspan has done his job by lowering the short-term rates, and I believe the Treasury is doing their part by trying to lower long-term rates by squeezing the middle where the 30-year mortgage hangs out. In so doing, the 30-year mortgage coupon will come down from 6.5% to 6.25% or even 6%. This would bring an immediate impact to the economy, the homeowner and to investors.
An investor who used to like 30-year T-bonds now should look to the long-term corporate bond or to the mortgage markets. Over the next three to six months, there will be billions in long-term corporate debt being offered, and the 30-year mortgage has always been a staple of the markets. So there are alternatives, but they appear to be a bit more risky than the 30-year Treasury bond, but they don't have to be. For example, the 30-year Ginnie Mae has a complete Treasury guarantee, so the risk is more in prepayments than in credit.
TSC: Your fund is weighted toward higher-grade offerings, and you've warned against lower-grade stuff recently. Have you moved even further away from the riskier end in recent weeks?
I wouldn't say we are moving further away from the riskier side. In fact, I believe that one of the new attractive spots on the
yield curve is the 30-year bond. I say this because I don't think inflation will be as much of a problem as others think -- in fact, it should decline from 2.5% to 1.5% over the next 12 months. If so, the long-term 30-year U.S. Treasury at 5.5 % represents decent, although not outstanding, value. An investor might also think about buying 30-year corporate bonds with A ratings, or higher, and survivability.
TSC: You have said investors should conserve cash. What percentage of their portfolios should be in cash, and when do you think people should put that money back into the market?
I've always admired those who do personal financial planning for a living (talk about putting it on the line), so I'd much rather leave the personal allocation questions for those experts -- there are just too many personal variables to consider: current income, life expectancy, age they want to retire, what state they want to retire to and, most important, their tolerance for risk.
Investors can put their money in the markets
, but they must do it wisely. Stick to high-quality, high-yielding investments such as high-quality Ginnie Maes or A-rated and higher 30-year corporate bonds.
My clue that it is time to get back into other bond sectors (corporates, emerging markets, high-yield) will be when I see a revival of confidence and risk-taking among consumers and businesses. This is one of the most critical indicators of a recovery, an economic snapback. Investors should also use this as an indicator that it might be time to get back into the stock market. You see, stocks, emerging market bonds, corporate bonds and high-yield bonds are all related to the economy in economic terms -- all four are not performing well currently and that's because we're in a recession.
Once confidence returns, the economy will turn, these four investments will turn and investors should consider reallocations. I see this turn taking place sometime during the second quarter of 2002.
, should the somber attitudes and cautious behavior we are now seeing in the aftermath of the attacks continue to persist, then recovery will be postponed deep into 2002.
TSC: What do you expect from the Fed at this point? And what are the perils of Greenspan's next moves?
I think we need to see a 50 basis-point reduction before the year ends (to 2%) before we see a change. And the Fed will continue to cut until they see some sign of a recovery taking place. But, they can't go much further than 2%. If they go below this, we'll start to look like Japan, and they don't want that.
Keep in mind that the lower and lower they go with interest rates, the less and less those who depend on CDs and money markets -- the elderly and the retired -- have to spend. So the Fed doesn't want to be responsible for their suffering. It's a very delicate balance they must strike. Stocks, and some bond sectors, will also continue to suffer until the turnaround begins -- and it looks like that will be sometime during the second quarter of 2002 if things continue as they are now.
TSC: At the Morningstar Investment Conference back in June, you predicted annual stock and bond returns of 5% in the coming years. Now, five months later,you've lowered that projection to a paltry 2%! What's going on?
The old clich¿ of "there's no such thing as a free lunch" came home to roost. I've said it before and I'll say it again, we've seen the creative side of capitalism with all the new dot-coms, like
, and the new technologies; now we've seen its destructive side. We like to call it "PBD" -- postbubble disorder. Before the bubble burst, consumers were drawing down on their savings, and banking on selling 100 shares of
to pay the bills. This "free lunch" had to come to an end and it did. To get out of this, Americans have to save again and, due to the tragedy, they have to regain their confidence in taking risk.
The days of 20% annual returns are over. When the turnaround takes place, it will be weak and anemic when compared with prior recovery cycles. Investors have started to realize that they need to change their expectations and become more realistic about the markets going forward.
TSC: How concerned should investors be about declining credit quality now?
An investor should always be concerned with declining credit quality. This is why I have been saying it's just not time to be getting back into the high-yield and corporate bond sectors. Once we see that revival in confidence and risk taking, that will be the time to get back into those sectors.
TSC: What do you like now? What are you putting your own portfolio?
Personally, I've begun to "invest" more time with my family -- talk about a good investment. I highly recommend it. In addition though, I like closed-end municipal bond funds traded on the
New York Stock Exchange
. There's about 75 of them, and they yield about 6% tax-free.
TSC: Do you see growth opportunities elsewhere, outside North America, in the near and long term?
Yes, in the Eurozone. You see, growth in the U.S. will slow sharply to about 2% annually over the next three to four years, compared to the robust pace of more than 4% experienced since 1997. Productivity gains in the U.S. have peaked and will revert closer to historical averages, producing a chain reaction of lower corporate profits, reduced investment, pressure on equity valuations and weaker growth. Anxious and overleveraged consumers will respond by reversing their negative savings rate, creating more of a drag on the economy.
Growth in the Eurozone, which never reached the levels seen in U.S. over the last three years, will at least match that of the U.S. Europe's economies are not burdened with U.S.-style investment and consumption bubbles. European growth will be supported by robust IT spending as the region plays catch-up to the U.S. Weighed down by weak banks, low consumer confidence and mounting public debt, Japan will contribute little to global growth over the next several years.
Weaker growth in the U.S., and worldwide for that matter, will prolong a disinflationary environment that will leave inflation in a range of 1% to 2%. The euro will strengthen against the dollar, helping keep European inflation below that of the U.S., as more European capital stays home amid lower returns and slower growth in the U.S. Temporary productivity gains from increased IT spending will also restrain European inflation.
TSC: Is there anything you like in the equities market?
Now that's an interesting question to ask someone who's been dubbed "the bond guy." But let me refer back to my comment on municipal closed-end bond funds, which are traded on the NYSE. Munis these days yield almost as much or more than Treasuries. You can buy these municipal bonds via closed-end funds, and for the most part they're AA quality instruments that can yield on average 6% -- and they're tax-free and very liquid. Now, am I "the bond guy" or what?
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