There are signs that the 35-year “investment supercycle” is drawing to a close, according to star bond manager Bill Gross, meaning investors need to prepare themselves for at least three decades of subdued returns and a new way of running money.
Gross joined Janus Capital in September 2014 after a high-profile departure from Pimco, the asset management house he founded 1971 with Jim Muzzy and Bill Podlich. Among other things, he became known for his idiosyncratically written investment notes – a tradition he has carried on at Janus.
The latest missive starts with the manager’s musings on his “sense of ending” and fear of dying before moving onto his argument that the bull run which has boosted asset markets for more than three decades is set to come to a close.
Over recent years, Gross has warned that markets look unsafe and, like other bearish commentators, has had to concede that he was too early with this view.
However, he notes that more “successful” fund managers who are neither perma-bears nor perma-bulls have started to suggest “the 35-year investment supercycle may be exhausted”.
He cites George Soros, Jeremy Grantham, Ray Dalio and Stanley Druckenmiller as being some of the high-profile managers saying the strong run in financial markets is at risk of faltering for an extended period of time, thanks to the distorted conditions created by the central bank’s experimental monetary easing policies.
Performance of indices over 20yrs
Source: FE Analytics
“They don’t necessarily counsel heading for the hills, or liquidating assets for cash, but they do speak to low future returns and the increasingly fat tail possibilities of a ‘bang’ at some future date,” Gross said.
“Savour this bull market moment, they seem to be saying in unison. It will not come again for any of us; unrest lies ahead and low asset returns. Perhaps great unrest, if there is a bubble popping.”
He also rejects the bulls’ ‘new normal’ scenario where growth and inflation both hover around the 2 per cent mark. Although these are not the most opportune conditions for bond funds, they would be supportive of jobs, profits and stock markets.
“Their ‘new normal, as I reaffirmed most recently at a Grant’s Interest Rate Observer quarterly conference in NYC, depends on the less than commonsensical notion that a global debt crisis can be cured with more and more debt,” he continued.
“At that conference I equated such a notion with a similar real life example of pouring lighter fluid onto a barbeque of warm but not red hot charcoal briquettes in order to cook the spareribs a little bit faster. Disaster in the form of burnt ribs was my historical experience. It will likely be the same for monetary policy, with its QE’s and now negative interest rates that bubble all asset markets.”
The crux of Gross’ argument is that growth is likely to remain far below what the bulls are expecting, as the global economy will continue to suffer from rising debt to GDP levels, ageing populations and technology replacing labour for years to come.
This repressed growth will combine with zero-based interest rates and an inability to escape the world’s ongoing debt crisis to create “the sense of an ending” for asset markets.
“Where can a negative yielding Euroland bond market go once it reaches minus 25 basis points? Minus 50? Perhaps, but then at some point, common sense must acknowledge that savers will no longer be willing to exchange cash euros for bonds and investment will wither.”
Performance of index over 6yrs
Source: FE Analytics
Given that the value of other financial asset prices are based on bond yields, he adds that there seems to be little room for growth in stocks as negatively yielding bonds effectively put a brake on P/E expansion unless earnings growth accelerates beyond historical norms.
Gross warns that the global financial system will start to splutter or even break down when investable assets pose too much risk for too little return.
The manager said: “We are approaching that point now as bond yields, credit spreads and stock prices have brought financial wealth forward to the point of exhaustion. A rational investor must indeed have a sense of an ending, not another Lehman crash, but a crush of perpetual bull market enthusiasm.”
This leaves investors in something of a pickle but Gross says the rational investor should not have to “breathe deeply as the noose is tightened at the top of the gallows”. Rather, he argues that a closer focus on risk/reward metrics are more important than ever.
“If yields are too low, credit spreads too tight, and P/E ratios too high, what portfolio or set of ideas can lead to a restful, unconscious evening ‘twixt 9 and 5 AM? That is where an unconstrained portfolio and an unconstrained mindset comes in handy,” he continued.
“35 years of an asset bull market tends to ingrain a certain way of doing things in almost all asset managers. Since capital gains have dominated historical returns, investment managers tend to focus on areas where capital gains seem most probable.”
“Hogwash. This is all ending. The successful portfolio manager for the next 35 years will be one that refocuses on the possibility of periodic negative annual returns and miniscule Sharpe ratios and who employs defensive choices that can be mildly levered to exceed cash returns, if only by 300 to 400 basis points.”
This seems to read like Gross has just said that that investors should buy nothing but absolute return funds – or incredibly defensive multi-asset funds – for some time in the future.
However, Premier senior multi-asset manager Simon Evan-Cook says he is more optimistic than Gross and cautions investors against positioning their portfolio for a single macro view, as this creates the risk of being severely disappointed if it fails to materialise.
“I think his grumpiness is largely based on being a bond fund manager in the US, as most bonds everywhere look expensive while US equities look similarly unappealing. That does leave the rest of the world’s equity markets though, which still look capable of generating a respectable positive return after inflation – especially if you follow a genuinely active investment style, such as value, that should give you excess returns above the market,” Evan-Cook said.
“We do obsess over making the funds robust in the event of a sell-off, but accept that we can’t control what prices the market will offer us for those assets as we move through that sell-off.”
“So the key thing is to make sure that those assets survive a sell-off and that we weren’t paying too much to hold them in the first place. Get either of those wrong and we’ll permanently destroy capital – the biggest crime in investment management.”
Premier’s multi-asset funds decides on whether to hold absolute return funds on the desired outcome of its portfolio’s rather than automatically allocating to them to protect against a possible collapse in market.
The managers currently has “plenty” of absolute return funds in their Premier Multi-Asset Absolute Return and Conservative Growth funds as these are the most defensive of its range, but nothing in the more aggressive Global Growth and Monthly Income funds.
“Would we ever own them in Global Growth? Never say never, but we’d need to be worried that markets were widely and dangerously overvalued, and we’d have to have, for example, a market neutral fund where we had faith in the manager’s ability to repeatedly add value,” Evan-Cook added.
Rob Burdett, co-head of multi-manager at F&C, also has some sympathy with Gross’ argument, especially about the type of fund manager who is likely to succeed in the difficult years ahead.
Burdett and co-manager Gary Potter currently use funds of this kind in their portfolios, but more to provide balance positions that are neutral on equities and underweight bonds rather than in anticipation of full market collapse.
“We use absolute return funds as one way to fill that gap but prefer more macro-aware strategies that might be able to move their views dependent on the prevailing inflation/deflation drivers,” he added.
Absolute return funds that the F&C multi-manager team prefer include Cyril Moulle-Berteaux’s Morgan Stanley Diversified Alpha Plus, Matthew Smith and Tom Morris' Majedie Tortoise and Tim Bond’s Odey Odyssey funds.
