The latest from Bill Gross is really excellent and hits on a point that I’ve often discussed here. Here’s the key line from his monthly letter:
“If monetary and fiscal policies cannot produce the real growth that markets are priced for (and they have not), then investors at the margin – astute active investors like PIMCO, Bridgewater and GMO – will begin to prefer the comforts of a less risk-oriented migration. “
I disagree with him to some extent when he says that the markets have not been priced for the real growth we’ve seen. In fact, we’ve seen booming corporate profits for years now and record EPS on the S&P 500. We’ve also seen very low inflation which doesn’t make the move in bonds entirely unjustifiable. Markets have not reacted all that irrationally to QE and the real economy so far. But his point does keep me up at night as well. And 2013 was a clear case of some irrational exuberance. Any year where corporate profits grow by a measly 4.5% and the stock market booms by 25%+ makes you wonder about how rational the moves are.
Of course, market prices are determined by the perceptions of its participants. And yes, being a behavioralist and someone who rejects the efficient market hypothesis, I do worry about how people perceive QE and whether it can distort market prices. After all, if a year like 2013 were to perpetuate we’d see markets that became severely distorted relative to underlying fundamentals. And all based on what? A false hope in a central bank that can’t deliver what it promises? We might not be at a point of severe disequilibrium yet, but the risk is looming.
Of course, the difference between Bill Gross and myself is that he probably sleeps on a much nicer bed and can rest calmly knowing that his financial future is much more secure than mine is. So I doubt he’s losing too much sleep over this. As for the rest of us….