The veteran fixed-income manager has taken an ultra-bearish stance in his outlook for financial markets in recent months, saying that the quantitative easing (QE) polices of the world’s leading central banks since the 2008 crisis are primary cause of a “distortion of capitalism” that is poised to stunt economic growth over the medium term.
Gross exited his former home Pimco, the fixed income fund house that he helped found almost 45 years ago, in September 2014 and joined Janus Capital in a move that took investors by surprise.
“Investors must be cognisant of future low, and in some cases negative, total returns in 2015 and beyond,” he said.
“Bonds, despite their ridiculous yields, will not easily be threatened with a new bear market. Investors should expect as well, that because of the slow unwinding of zero per cent rates in the US, that US and global stocks will be supported. Their heyday is over, however.”
According to FE Analytics, both US equities and bonds have rallied hard since the financial crisis but have now reached levels where valuations and yields are seen as stretched by a number of managers and commentators.
Performance of indices over 7 years
Source: FE Analytics
In a tone that is even more cataclysmic than other recent predictions from the stars of the bond market, Gross says that capitalism could even unwind as central bankers become increasingly powerless to influence markets.
“Capitalism depends on hope – rational hope that an investor gets his or her money back with an attractive return. Without it, capitalism morphs and breaks down at the margin. The global economy in January of 2015 is at just that point with its zero per cent interest rates,” he argued.
“Officials at the Federal Reserve seem to now appreciate the hole that they have dug by allowing interest rates to go too low for too long. Despite reasonable growth, some of them recognise the system’s distortion if only because inflation is going down, not up, in the process.”
He says this will spur the Fed to raise interest rates in late 2015, following five years of historically low interest rates.
“It won’t however, move quickly – capitalism has been damaged by the change in rules since 2008. Caution, therefore, will prevail in the US and elsewhere for a long time.”
Gross says returns in the real – or non-financial – economy are too low partly because of the “misguided efforts” of central bankers and expects them to stay low for several years.
“There is no doubt that structural secular stagnation factors such as demographics, high debt and technology have contributed significantly as well. Fiscal policy has been anaemic since 2010,” he added.
“Capitalism’s distortion, with its near-term deflation, poses a small but not insignificant risk to what my mother warned was the final destination for all games – entertainment or real. In the end, she said, all of the tokens, all of the hotels, all of the properties – they all go back in the box.”
“The strong odds are that 2015’s distorted capitalism continues with anaemic growth.”
The manager adds that deferred investment outside of the non-financial economy is the real threat to economic growth.
“With interest rates near zero and banks and other financial intermediaries sitting on trillions of dollars, euros and yen, why wouldn’t they lend it out to the private economy in hopes that they could obtain a higher return on their money? Sounds commonsensical, doesn’t it? Not in reality,” he said.
“Still, even with the US growing at an acceptable rate for now, its recovery over the past five years has been anaemic compared to historic norms, and other developed economies are faring much worse. Many appear to be facing new recessions even with interest rates at 0 per cent or – incredibly – negative rates. German and Swiss five-year yields cost the lender money.”
The European Central Bank (ECB) is the latest major central bank to unveil a full-blown QE programme, a policy that Gross believes has heavily distorted markets and set up an ongoing low growth environment.
“Before 2008, economists and historians would not have believed such a condition could exist, but here it is with individual sovereign countries and their respective central banks pushing each other out of the way in a race to the bottom of interest rates – wherever that is – and a race to the bottom in terms of currency valuations.”
“Competitive devaluations and the purchase of bonds at near zero interest rates is indeed a significant distortion of the markets and – more importantly – capitalism’s rules which have been the foundation of growth for centuries.”
“Most importantly – because the markets and the financial sector are ultimately the servants of the real economy – growth is challenged and stunted.”
