Fed Easing to Signify End of Bull Market, Gross Says
Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co., said a renewal of asset purchases by the Federal Reserve will likely signify the end of the 30-year bull market in bonds.
“Check writing in the trillions is not a bondholder’s friend,” Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website today. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”
The Fed, led by Chairman Ben S. Bernanke, will announce another round of large-scale asset purchases when policy makers meet next week after deploying $1.7 trillion to pull the economy out of the financial crisis, according to a survey of the 18 primary dealers that trade debt with the central bank. Fed officials, who already cut interest rates almost to zero, are discussing more purchases of Treasuries to flood markets with cheap money as well as strategies for raising inflation expectations to prevent stagnating prices from undermining the recovery.
Gross, a founder and co-chief investment officer of Pimco, said in March that bonds may have seen their best days while making an argument for investors to own fewer. He reduced holdings of government-related debt in the Total Return Fund for the third straight month in September, after the securities accounted for 63 percent of assets in June, the highest since it held an equal amount in October 2009.
Less Government Debt
The $252 billion Total Return Fund’s investment in government debt was cut to 33 percent of assets in September, from 36 percent the previous month, according to the company’s website. Pimco doesn’t comment directly on monthly changes in portfolio holdings.
The yield on the 10-year Treasury note dropped from a 2010 high of 4.01 percent in April to a low of 2.33 percent on Oct. 8, according to Bloomberg data, as investors purchased Treasuries in anticipation of further asset purchases by the central bank. The record of 2.04 percent was set in December 2008.
“Having arrived at its destination, the market then offers near zero percent returns and a picking of the creditor’s pocket via inflation and negative real interest rates,” Gross wrote. “It will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment,” Gross wrote.
Treasuries have returned 8.3 percent this year after losing 3.7 percent in 2009, according to Bank of America Merrill Lynch indexes.
The Fed is driven to further easing due to low inflation and a threat of deflation, where falling asset prices, including home values, result in consumers and businesses that are less willing to spend and invest. Inflation, a rise in the prices of goods and services, would enable more value, production and consumer activity.
“This is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin,” Gross wrote. “I call it a Sammy scheme, in honor of Uncle Sam and the politicians -- as well as citizens -- who have brought us to this critical moment in time. You and I, and the politicians that we elect every two years, deserve all the blame.”
Policy makers have historically focused on containing inflation rather than preventing deflation. Core consumer prices, which exclude food and fuel, were little changed in September, capping a 0.8 percent increase in the past 12 months, the smallest year-over-year gain since 1961.
Inflation climbed to a 14.8 percent annual rate in March 1980, driving 10-year yields to 13.65 percent that year and to an all-time high of 15.8 percent the following year. Former Federal Reserve Chairman Paul Volcker broke the back of inflation by raising rates as high as 20 percent, even as the economy slipped into the longest post-World War II recession to win back confidence among investors.
By the time Volcker stepped down from the Fed in 1987, inflation slowed to 4.3 percent and benchmark borrowing costs were 6.75 percent.
“We are, as even some Fed Governors now publically admit, in a ‘liquidity trap,’ where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there,” Gross wrote. “Escaping from a liquidity trap may be impossible, much like light trapped in a black hole.”
Under what Pimco calls the “new normal,” investors should expect lower-than-average historical returns with heightened regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy.
“If QEII cannot reflate capital markets, if it can’t produce 2 percent inflation and an assumed reduction of unemployment rates back towards historical levels, then it will be a long, painful slog back to prosperity,” Gross wrote.
As part of adjusting to a new normal, Pimco began offering equity funds in April, and had inflows of about $1 billion, Pimco said in September. The firm moved into stocks to allow customers to diversify their holdings as the global economy changes and areas such as emerging markets outperform developed regions.
Pimco added to its mortgage holdings in September to 28 percent of assets, from 21 percent the prior month. Pimco also expanded its emerging-market debt to 12 percent last month, the highest since at least September 2006. Non-U.S. developed debt was unchanged at 6 percent.
The Total Return Fund, also the world’s biggest mutual fund, handed investors a gain of about 11.78 percent in the past year, beating about 76 percent of its peers, according to data compiled by Bloomberg. Pimco, a unit of Munich-based insurer Allianz SE, managed $1.236 trillion of assets as of September.
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