Bill Gross: The New Big Idea From the World’s Biggest Investor

By Dr. Steve Sjuggerud, Chairman, Investment U
Thursday, May 26, 2005: Issue #440

With a half-trillion dollars under management, Bill Gross has to be the world’s largest investor

Gross oversees investments at PIMCO, where’s been for 35 years. Investors don’t give a man a half-trillion dollars because he’s a nice guy. They give it to him because he knows what to do with it.

With his enviable, multi-decade track record, Bill Gross is definitely worth listening to. Fortunately, a few times a year, he shares his outlook with us. And in his latest outlook (available at http://www.pimco.com) Gross shares with us his “big idea” – what will drive the world in the next five years.

The basic thesis from Bill Gross is this: The big rises in asset prices are over, as we’ve just about reached the logical limit of the benefit of lower interest rates. Specifically, lower interest rates in the future won’t have as positive an effect as falling rates in the past have.

Bill Gross’ Modern Test Bed: Japan

Gross points us in the direction of Japan, where interest rates have been next to zero for the 21st Century, and yet asset prices have been falling. Even with interest rates next to zero in Japan, there’s no inflation there. And again, even with interest rates next to zero, stock prices and real estate prices have still managed to trend lower and lower.

Bill’s point is simple: There is a limit somewhere to how much our current low interest rates can push asset prices. In Japan, clearly, low interest rates aren’t doing any good any more. Bill says we’re close to that point in the U.S., too.

Gross also offers up some relatively simple math in his comments, based on inflation-adjusted government bonds. And he convincingly shows that we’ve really reached the end of the benefits of our current low interest rate environment. Specifically, Gross says:

” It will be difficult to generate U.S. inflation higher than our current 3% even if interest rates fall further. If 3% inflation is all we can get from the asset inflation of the past five years asset, it’s hard to believe that we get [any higher asset prices] from what’s left. The potential to reflate via interest rates is nearly over.”

What Could Do Well in the Bill Gross Scenario

While Bill is bearish on assets like stocks and real estate, he expects interest rates to trend lower, so he’s therefore optimistic about bond prices, expecting interest rates to go even lower:

“If we had to forecast (and we do), we believe a range of 3 – 41/2% for 10-year [U.S. government bonds] will prevail during most of our secular timeframe and that yields on Euroland bonds will be slightly lower.”

Gross is worried about the reaction of investors when the realization of single-digit returns at best in stocks and real estate sets in, and what these investors will do when they figure it out:

“The inherent leverage throughout the global financial system will pose a danger to risk-oriented markets (stocks, high yield debt, CDO structures, real estate) as owners gradually realize their returns can no longer be pumped anywhere near double-digit expectations.”

So where to from here? Bill Gross offers up his assessment:

“As to happy endings in the global economy and financial markets? Well some assets – high quality bonds, and certain commodities in limited supply among them – may continue to do well; other risk-oriented holdings can be pumped only a little bit further.”

In short, the world’s biggest money manager has 35 years experience doing what he does. It’s more than an understatement to say that he’s been right more often than not.

And right now, the world’s biggest money manager says that interest rates are extremely low, and yet they will go lower. He goes on to say that the further “pumping up” of asset prices by lowering interest rates that had worked in the past won’t have the same effect going forward.

Bill Gross can say his three- to five-year outlook in fancy words But sometimes plain ones are best:

Stocks and real estate are likely to disappoint. Bonds and commodities could do well. Playing it safe for the next three to five years is the right way to go.

Good investing,

Steve

Today’s Investment U Cribsheet

• To read the latest comments from legendary fund manager Bill Gross, visit http://www.pimco.com
• There are two books about Bill Gross I’d recommend the first: Bill Gross on Investing over The Bond King. Neither book is great, but the first gives you a much better insight into the world’s biggest money manager.

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