http://www.pimco.com/LeftNav/Late+Breaking+Commentary/IO/2006/IO+April+2006.htmIn fancy language, Bill Gross says that current bond indexes do not pay an investor for risk. "Bond and asset managers alike (and PIMCO fits both descriptions) are faced with global real interest rate valuations capped at 2% in major markets, and yield spreads almost everywhere that suggest maximum future bond returns of 5-6%. Equity prospects are not much better except in high growth export dominated economies. Commodities and real estate of course are legitimate growth and inflation sensitive asset classes, and due to higher risk and in the case of commodities, growth of the BRICs, these assets will logically provide higher returns over the long term....That leaves the U.S. with its increasingly hollowed out manufacturing core as the near certain loser in currency valuations going forward. To be blunt, the dollar must go down as it loses its carry."Gross' main points:1. Bonds are overvalued, across the board. Risk premia on all bonds are too low. Gross agrees with Greenspan, that this will end badly (that is, with higher interest rates, and lower bond prices). Gross thinks that it is riskier to try to index (because he expects a widespread collapse) than to concentrate in safer areas.2. The dollar is overvalued.3. Gross recommends the following assets: --cash and "near cash" assets, such as eurodollar tranches that mature in 2007-2008. -- Commodities-- alternatives to the dollarThe 5-year TIPS is now yielding about 2%. If a giant, like Gross, can't do any better than that, it is starting to look good.Wendy
Wendy,Gross is an experienced, thoughtful commentator who isn't afraid to make forecasts, unlike the typical commentator who will tell you with 100% certainty why what has already happened has happened as it did. But what has to be realized that a forecast is a forecast. It is an attempt to assess current conditions and trends and to extrapolate possible outcomes. He is not making predictions. He's making forecasts. If his forecasting abilities have a good track record, then that is the extent to which they can be trusted. Determining the trustworthiness of those forecasts (or anyone's forecasts) is a matter of doing some research. How good is his track record? It is very much to his credit that he is willing to be public about his forecasts. But what those forecasts are worth has to be determined. All of that having been said, it is highly likely, as he has said so in the past of his other forecasts, PIMCO has already make use of his judgments and is already moving money in line with his forecasts. So the information is somewhat stale by the time it is released to the public. That's always going to be the case. By the time a small investor hears about something, the smart money has already made their move. What the smart money is now hoping will happen is that the crowd will follow, so they can be sold to and the smart can move ahead. But, because everyone also knows that is the game, then counter-plays within counter-plays within counter-plays can happen in truly Byzantine, labyrinthian ways, the deciphering of which will drive you crazy. In short, if you have an investment plan, stick with it. A forecast isn't a prediction. (A clear-cut epistemological distinction can be made between the two.) But for all practical purpose, the two are no different than each other, and both suffer from this same flaw: No one can predict the future, nor can anyone [if the research can be trusted] make very good forecasts about financial matters. Gross is making an informed, shrewd guess. Whether it is smart to bet against him is another matter. My feeling is that small investors (the ants) have to know what big investors (the elephants) are doing, so they don't get trampled in the rush for the exits. My feeling, also, is that small investors, due to the fact that they can be nimble, can make serious money by betting against the elephants. But that is also a sophisticated game that the beyond the means and interests of the “average” small investor.So, where does that leave the “average” small investor? Between a rock and a hard spot, right? The smart money has already made its move, but trying to fade the crowd is beyond his means. If that investor has a plan, then his plan should be adhered to. To do otherwise is to be blown, hither and yond, by every whirlwind of opinion that blows across the land. Dante called such people “trimmers” and put them in the first ring of hell, which was a kindness. The lower rings were much worse. But he needn't have put any of them in hell, because such people create their own hell for themselves for never knowing who they are or what they stand for. Or as Yogi Berra put it: “If you doesn't know where you're going, it's pretty hard to get there.” Gross is smart, experienced, articulate, and extremely decent. He's worth reading. He's worth paying attention to. But each person has to ask her or himself whether what he is saying applies to how their own portfolio is constructed and managed. That's what matters: one's own investment plan. If that plan includes bond indexes and those indexes are forecast to lose value, then a person has several choices: (1) Ride it out. (2) Tighten stops and be willing to get kicked out at a preset-loss point.(3) Create a hedge against one's holdings of the index. (4) Reverse and go short.There's a lots of possible responses, not the worst of which is to stick with one's investment plan and to ignore the noise of opinion. Charlie
Seems to me it weren't so long ago, Mr. Gross was telling us yields had peaked and were going down (maybe to 3% on long Treasuries). They've gone up since then.I'm just holding my breath that folks will keep buying stocks and selling bonds until the next 10-year and 5-year TIPS auctions. If fixed yield get better from their, I'll keep rolling over CDs into TIPS.
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