Pragmatic Capitalism

Capital for Living a More Practical Life


Bill Gross, arguably the most powerful money manager in the world, has joined the ranks of Jeremy Grantham  in saying stocks have risen due to artificial influences and are now substantially overvalued.   In his latest monthly outlook Gross says “almost all assets appear to be overvalued on a long-term basis”.

He goes on to explain the long-term artificial price climb and the influence it has had on investors:

“The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them. How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.”

Gross says the result of these actions is that the current economic environment does not justify the high asset prices:

“What has happened is that our “paper asset” economy has driven not only stock prices, but all asset prices higher than the economic growth required to justify them.”

Gross even says policy makers know they must help to prop up prices and says we are tracking Japan’s path in an effort to keep the patient alive:

“This is where it gets tricky, however, because policymakers, (The Fed, the Treasury, the FDIC) recognize the predicament, maybe not with the same model or in the same magnitude, but they recognize that asset prices must be supported in order to generate positive future nominal GDP growth somewhere close to historical norms. The virus has infected far too many parts of the economy’s body, for far too long, to go cold turkey. The Japanese example over the past 15 years is an excellent historical reference point. Their quantitative easing and near-0% short-term interest rates eventually arrested equity and property market deflation but at much greater percentage losses, which produced an economy barely above the grass as opposed to buried six feet under. The current objective of global policymakers is to do likewise – keep the capitalistic patient alive through asset price support, but at an “old normal” pace if possible, six feet or 6% in U.S. nominal GDP terms above the grass.”

In conclusion Gross states that the rally in risk assets is likely at its pinnacle despite the Fed’s efforts:

“If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get. Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.”

His full commentary can be found here.

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