No New Normal as Stocks to Bonds Rallied Like the 1990s
Pacific Investment Management Co.’s new normal, the prediction that global economic growth and investment returns would tumble, is proving half right.
Bill Gross and Mohamed El-Erian, the co-chief investment officers of the Newport Beach, California-based money management company that oversees $1.9 trillion, correctly foresaw that global expansion would remain sluggish. The world’s economy probably grew 2.2 percent last year, below the 3.2 percent average of the decade before the 2008 financial crisis, according to World Bank data compiled by Bloomberg.
Pimco’s outlook, announced in 2009, was less accurate for financial assets as unprecedented stimulus by central banks drove up demand for stocks and bonds. Fixed-income securities around the world returned more than the average of the past 16 years in 2012 and the value of global equities increased by $6.5 trillion as the MSCI All-Country World Index rose 13.4 percent.
“They’ve underestimated how big the policy response would be and what type of positive impact it would have on financial markets,” said Jay Schwister, a managing director and senior money manager in Milwaukee at Baird Advisors, which oversees $17 billion of bonds. “From the real economy standpoint, the new normal that Pimco forecast is pretty much playing out,” he said Jan. 3 in a telephone interview.
Gross, 68, who manages the world’s biggest bond fund, and El-Erian, 54, the firm’s chief executive officer, captured the imagination of investors in an October 2009 report when they forecast a “new normal” for the global economy, where “the deleveraging, re-regulation and de-globalization that will weigh on growth is likely to be the new model in the foreseeable future.” They predicted returns on assets “half of what they were during the previous 10-20 years.”
What they didn’t foresee were the steps central banks would take. Policy makers from the Federal Reserve to the People’s Bank of China pumped more than $6 trillion into the global economy as they bought everything from Treasuries to gilts, boosting their balance sheet assets to $14.09 trillion as of June 2012 from $4.99 trillion in May 2006, according to Bianco Research LLC research cited by Pimco.
“Policy distortions cannot continue indefinitely,” Saumil Parikh, Pimco’s co-head of asset-allocation strategy, wrote Jan. 4 in an e-mail. “2013 will be a year of reversion to the medium-term ‘new normal’ view for both the economy and financial markets.”
While equity markets bucked the new normal trend last year, the longer-term average proves Pimco is right. Stocks globally returned an average of 4.6 percent in the past three years, when including a 9.42 percent drop in 2011, the MSCI All-Country World gauge shows.
U.S. government debt of all maturities returned 2.16 percent in 2012, the least since they lost 3.7 percent in 2009, according to indexes from Bank of America. It may offer investors little again this year. Ten-year Treasury yields will rise to 2.14 percent by the end of 2013, from 1.76 percent on Dec. 31, 2012, in the first increase since 2009, based on the weighted average estimate of 77 economists surveyed by Bloomberg News.
The Standard & Poor’s 500 Index will gain 6.4 percent after rising 13.4 percent in 2012, according to the median forecast of 16 Wall Street strategists in a separate Bloomberg survey.
Bonds around the globe returned 5.7 percent in 2012, more than the 5.4 percent average in the 16 years since the inception of Bank of America Merrill Lynch’s Global Broad Market Index.
U.S. speculative-grade, or junk, debt earned 15.6 percent, compared with the yearly average of 11 percent in the 1990s. High-yield securities are those rated less than Baa3 by Moody’s Investors Service and below BBB- by Standard & Poor’s.
Debt backed by subprime home loans issued before the housing market collapsed in 2007 gained 41 percent on average, Barclays Plc index data show.
The best government bonds to own last year were issued by Europe’s most troubled nations. Greek debt topped the 26 sovereign markets tracked by Bloomberg and the European Federation of Financial Analysts Societies, rising 97.3 percent. Portugal’s returned 57 percent, while Italy’s gained 21 percent.
“Central banks basically wrote the ticket, so to speak, for bond markets in 2012,” said Tad Rivelle, chief investment officer for fixed income in Los Angeles at TCW Group Inc., which oversees $85 billion of assets. “If you’re just looking at 2013, largely speaking we’re going to see a repeat, a doubling down if anything, on quantitative easing and stimulative monetary policies,” he said Jan. 3 in a telephone interview.
Rivelle said he favors mortgage securities without government backing, leveraged loans and emerging-market debt. TCW’s Metropolitan West Total Return Bond Fund returned 11.4 percent last year, beating 98 percent of its peers, Bloomberg data show.
Treasuries fell last week as Congress passed legislation that averts income-tax increases for most Americans and minutes of the Fed’s last meeting indicated that policy makers may cut back on stimulus sooner than bond investors anticipated.
Ten-year note yields ended last week at 1.90 percent after rising to 1.97 percent on Jan. 4, the highest level since April. They rose about 20 basis points, or 0.2 percentage point, from the Dec. 28 close, according to Bloomberg Bond Trader data. Yields were unchanged at 7:19 a.m. in New York.
The S&P 500 (SPX) Index of U.S. stocks added 4.6 percent in its biggest weekly gain in more than a year. The Stoxx Europe 600 Index advanced 3.2 percent. The index returned an average 15.3 percent in the 10 years ending in 2000.
The MSCI world gauge’s 2012 increase topped the 9.4 percent annual average of the 1990s.
Fed Chairman Ben S. Bernanke and European Central Bank President Mario Draghi in 2012 pledged more bond purchases amid the slowest global economic growth since 2009. Shinzo Abe, whose Liberal Democratic Party won Japanese elections last year, has called for the central bank to undertake unlimited easing to revive economic growth.
“Last year, if you look at some of the biggest moves in the market, they came after policy announcements,” Quincy Krosby, market strategist for Newark, New Jersey-based Prudential Financial Inc., which oversees more than $1 trillion, said Jan. 3 in a telephone interview. “The new normal is markets predicated on central-bank action.”
From John Paulson’s prediction for a collapse in Europe to Morgan Stanley’s warning that U.S. stocks would decline, almost all of Wall Street’s calls were wrong in 2012 as even the largest banks and most-successful investors failed to anticipate how government actions would influence markets.
Pimco, a unit of Munich-based insurer Allianz SE, was among the beneficiaries of the rise in markets. Gross’s $285 billion Total Return Fund (PTTRX) gained 10.4 percent and beat 95 percent of its peers last year, Bloomberg data show. The performance marked a turnaround from 2011, when the fund lagged behind 70 percent of competitors.
Gross is concerned the same central-bank stimulus that ignited asset values will lead to declines.
“Investors should be alert to the long-term inflationary thrust of such check writing,” Gross wrote this month in a report. “While they are not likely to breathe fire in 2013, the inflationary dragons lurk in the ‘out’ years towards which long- term bond yields are measured.”
U.S. core consumer prices, which exclude food and energy, are forecast to increase 1.7 percent in 2012, according to a Bloomberg survey.
Employers added workers in December at about the same pace as the prior month. The unemployment rate held at 7.8 percent after the November figure was revised up from a previously reported 7.7 percent.
Gross domestic product is forecast to expand 2 percent in 2013 after increasing 2.2 percent last year, according to the median estimate of economists surveyed by Bloomberg.
“The economy is firing along, but it’s not strong enough for the Fed,” William O’Donnell, head U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut, one of 21 primary dealers that trade with the central bank, said Jan. 3 in a telephone interview. “We expect another year of new normality, real GDP growth somewhere on the order of 1.75 to 2 percent for the whole of the year.”
While stock market gains may be muted in the first quarter as Obama and his opponents struggle to resolve deficits and the economy grows less than 1 percent, equities will likely rally as much as 10 percent in 2013, according to Laurence Fink, the CEO of New York-based BlackRock Inc., the world’s largest asset manager, with assets of $3.7 trillion.
“Over the long run, the fundamentals of American corporations are very strong, the fundamentals of the American economy are as positive as I would ever remember in terms of housing, energy, our banking system,” Fink said Jan. 2 in an interview with Erik Schatzker and Scarlet Fu on “Market Makers” from Bloomberg Television. “We have great fundamentals in our country that no other country in the world has.”
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