In April of last year, PIMCO’s Bill Gross, the world’s largest bond fund manager, penned an article called “A Man in the Mirror”. Apart from the terrible quote from the “how soon we forget what a freak he was and forgive his very questionable transgressions with children” Michael Jackson, it was a great article.
Michael Jackson dangling his baby out a hotel window</a> </div>
Bill Gross and his terrible choice of rock star role model</a> </div>
Who knows if Bill was trying to be “hip” and relate to the “younger generation” but modelling your article after Michael Jackson shows a disturbing lack of taste (and or judgment).
However, let’s forgive Bill’s poor choice of role model, and dig a little deeper into the article.
The article examines the secular 30 year bull market in bonds and credit expansion. Gross correctly questions whether all the great investors are really as “great” as everyone thinks they are, or whether they were merely surfing this giant wave that has lifted all boats.
Gross admits that maybe even his success is merely a reflection of this extremely attractive period for investing:
But let me admit something. There is not a Bond King or a Stock King or an Investor Sovereign alive that can claim title to a throne. All of us, even the old guys like Buffett, Soros, Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch, that an investor could experience. Since the early 1970s when the dollar was released from gold and credit began its incredible, liquefying, total return journey to the present day, an investor that took marginal risk, levered it wisely and was conveniently sheltered from periodic bouts of deleveraging or asset withdrawals could, and in some cases, was rewarded with the crown of “greatness.” Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch.
I am very sympathetic to Bill’s worry that we have had a perfect environment for investing, and that this era is drawing to a close.
Since we hit the highs in interest rates in the early 1980s, it has basically being a one way ride straight down. Have a look at this extremely long term chart of 10 year US Treasury Yields:
The slope downward since 1982 is breathtakingly steep. This risk free rate is the rate upon which all other assets are discounted. Given that it has only being going down, it is no wonder that all other asset prices have been going straight up.
However, how long can this rate stay down here?
I contend that the age of low interest rates is drawing to a close. We are nearing the end game of this ever increasing credit expansion coupled with decreasing interest rates.
There are many reasons that I feel so strongly about this, but at the heart of my argument lies the belief that over the last couple of decades two big factors have masked the inflation that we would have normally experienced. Both the rise of China and the fall of the Berlin Wall caused wage growth to be extremely muted during the last 20 years. This allowed Western Central Banks to pursue monetary policies that were way too accommodative and thus encourage a level of borrowing that has been unprecedented. We have now borrowed to the point where there simply is no turning back and the only way forward is to inflate our way out of the mess.
I have long argued that Central Banks have been behaving completely irresponsibly for the last couple of decades. However, given that they have facilitated such a ginormous increase in global debt, the only way to reset the system is to get even more irresponsible and create inflation. There is no way that we can grow our way out of this debt burden. And there is even less chance that we would be able to stomach an Austrian economic style default depression. No, there is no solution to the problem except to inflate.
For me, the only question about this end game is the timing.
I am not sure if we are going to get another 2007/8 credit crash before we really inflate, or whether we will be able to keep the juggling balls of ever increasing credit expansion in the air for another few years, but eventually the end result will be inflation.
But there are some clues that the end of this 30 year bond bull market might be nearer than most think.
The fact that it is nearly unanimous that inflation is not a problem should give you great concern.
When did you last see the supposed market “pros” correctly set up for a crisis? Whether it was Long Term Capital, or the Dot Com bubble, or the real estate bust, the “pros” always convince themselves that the danger is smaller than the doomsdayers proclaim. The “pros” will never be set up to deal with the surprise. If they were, it wouldn’t be a surprise.
Therefore the fact that inflation is judged to be such a non-worry should be the greatest investment signal you could ask for.
But there are a couple of other great anecdotal signals that bring us back to Bill Gross and his article. PIMCO is the world’s largest bond fund. They have benefited from the massive bond bull market of the last 30 years more than most.
A couple of years ago, in the midst of the optimism for all things fixed income, PIMCO went ahead and decided to build a brand new gleaming office building in their hometown of Newport Beach California.
PIMCO’s new building</a> </div>
There is a long history of companies building shining monuments to their over optimism right near the top. Bear Stearns, Myspace, TimeWarner, etc… the list is long. PIMCO’s new building is not a good omen by any means.
And then there is the recent feud between the two managing partners at PIMCO – Bill Gross and Mohamed El-Erian. Recently El-Erian quit as head of PIMCO after complaining about Bill’s treatment of the staff and himself. The feud got embarrassing when Gross went all Richard Nixon thinking everyone was conspiring against him.
Finally, Bill’s $200 million pay package started to hit the papers (who knows maybe Gross was right that El-Erian was planting stories to make him look bad) and clients started pulling their money from PIMCO.
Back to Gross’ article about the man in the mirror. Gross wrote about the potential that maybe the epoch of easy investing was over. If so, he couldn’t have timed his company’s expansion more poorly. And if this is the start of a move to higher rates, I hate to see what the fighting will be like when returns really start going south.
I know this is all anecdotal, but I view PIMCO as the poster child for the bond market. My suspicion is that this downhill slide for PIMCO (and the bond market) has just started and that Gross’ article will be way more prescient than he would have ever predicted.
Instead of El-Erian quitting, Gross who is the older man, should have taken his article to heart and hung up his skates at the top of his game in April 2013.
US 10 Year Yields</a> </div>
Instead, even though he warned of the dangers, Gross was over confident:
What I do know, is that, like Michael Jackson sang in his brilliant, but all too short lifetime, I am and will continue to look at the man in the mirror. PIMCO, Gross, El-Erian? – yes, we’re lookin’ good – in this epoch.
Remember the “pros” never see it coming… (and old guys like Gross have terrible taste in music… MJ brilliant?)