Bill Gross' 'New Normal': Just the Same Old Normal After All

Bill Gross and his PIMCO shop have started using a term for our economic future, calling it "the New Normal." I hate this term. It is the same thing as saying, "this time it's different". It is never different. The same old story is played over and over. The costumes might change, but the story's the same. It is a bit arrogant for the PIMCO shop to think they are the first to find this new thing.

Mario Gabelli and Gross were on CNBC Wednesday morning at the same time. Mario made the point to Bill that the past 100 years saw a 4-5% annual appreciation in the stock market, so if we average 4-5% per year for the next 100 years, then it really is not so new, but is in fact quite an old average. Bill did not have a good rejoinder to this point. Score one for Gabelli. Gross and Gabelli also agree that a good manager can add a few points of "Alpha" to that average return. So, 7-8% is possible with good portfolio management, in a very low inflation environment.

What is really important, after all, is not the nominal return, but the real, or net of inflation, return. PIMCO is not projecting anything "New" here. In the very long run (hundreds of years), "Real Return" averages 2% to 3%. Gross is not saying that will change. What he says will change is nominal return which averaged 8-10% from 1929 to 2005. But this was also a period of higher than historical average inflation due to loose dollar policies in the 1930s and again in the 1970s. If inflation returns to its long run average of 2%, then the "New Normal" of 4 to 5% has an embedded 2 to 3% Real Return, which is the old normal. I am not sure why Bill Gross is making such a big deal about it.

"The new normal basically recognizes that we're in an economy that's de-levering and that we'll move to an average level that's lower than before," Gross said. "We're de-levering, loans are going to be less available…homeowners are going to have to put 20% down now, as opposed to zero."

The Federal Reserve is likely to keep rates at the same level for a while, because the economy would need to grow by nominal rates of 4% or 5% to prevent debt from destroying growth, Gross said. "They (the Fed) have to stay low because the embedded cost of debt (interest payments) in the economy is 6 to 7%," of GNP, said Gross.

This brings up an interesting quandary for many of the Bears who frequent the investing world today. Bill Gross, who many consider to be the world's leading private sector expert on the future of interest rates and bond prices, says they are staying low and must be kept low in order to achieve his "New Normal." Excess productive capacity and an emerging market with excess and cheap labor also suggest this future reality. Gross implies a long period of low inflation and low return. This really undermines the Bear argument for high inflation and / or continued crashing of the markets (which is inherently deflationary; never really understood how the Bears expect high inflation and high deflation simultaneously, which underscores how weak is the Bear argument).

As a member of the "baby boom" generation (like Gross) approaching retirement, a low inflation environment, with historical 2 to 3% Real Return sounds almost ideal to me. I think I will like Bill Gross' "New Normal."

Comments

[John Ryskamp:]

Except that demand will collapse, so you will not get your normal--new, old or otherwise.

Oct 28 07:02 PM

[Crashnburn:]

Historically, maybe 1/3rd of mutual funds outperform their benchmark indicies. This is not even taking survivorship bias into account. You can't identify the better managers a priori, and winners don't repeat.

Thus, trying to get alpha consistently from a manager is more a matter of luck than anything else.

Finally, study after study has shown that the lower a fund's expenses, the better its performance, in good times and bad.
The limit to reducing a fund's expense is the index fund; whether mutual fund, or ETF. Generally, the ETF will be cheaper.

I'll take my market returns, and enjoy doing better than 2/3rds of the managed funds in each of the asset classes I own by owning index funds.

Oct 28 07:04 PM

[damienhaas:]

It is called Stagflation. The commodities price is goes up as a Hedge for inflation as nations who has surpluses like China will continue buying. So If you want to call a Bull market in commodities, go ahead. However the housing prices and wages continue to fall, that is in US. We have less spending power + high commodities price. Now is it a case for long term Bullish case?

Oct 28 08:48 PM

[Robert Mart...:]

Brian,

I agree with Damienhaas, above: We may see low inflation overall in the future, because wages and rents are falling. But commodities are headed higher, as emerging markets displace the U.S. as the engine of global demand. This is a terrible outcome for most American workers, as their purchasing power collapses. Corporate profits, on the other hand, will be just fine, as outsourcing cuts costs, and as corporations shift their assets to high-growth, high-return markets overseas. This disconnect underlies "The Deflation of the American Dream." seekingalpha.com/artic...

For another view on Bill Gross's latest update, I highly recommend Ed Harrison's article:
seekingalpha.com/autho...

Ed is quite insightful.
Rob

Oct 29 12:32 AM

[Robert Mart...:]

Brian,

Sorry, the correct link to Ed Harrison's article is...

seekingalpha.com/artic...

Rob

Oct 29 12:43 AM

[Past Tense:]

I for one like the positive tone of your article, I get rather sic of the multitude of 'doom purveyors' who appear so wise because they make the 'we're all doomed case' with such conviction (Gold bugs being the absolute worst). In fact, I always deduct 10 IQ points from those types, because its so easy to create fear in others.

Perhaps Bill Gross is simply talking down expectations of longer his term returns, therefore making it easier for PIMCO to out perform his gloomy expectations, it's like setting your own exam.

I tend to believe Buffet (who is about the only person on earth to get the better of Goldman Sachs) when he said "America's best years are in front of us", South East Asia (think America in the 50s) is going gang busters with 100s of millions coming into wealth, how can the world NOT prosper?

So, what will bring us undone? Don't have yourself on, you like me, have absolutely no idea. I tend to think things will get better but if they don't then it will be because of something we least suspect (otherwise we would've invested in its solution), so stop thinking doomsday solutions, put Grandma's gold back in her jewelry box, do some trading and kick a football around with the kids this afternoon (life's pretty damn good really and a lot better than the alternative)...

Oct 29 12:48 AM

[Brian McMorris:]

Robert, I agree with most of what you say.

Actually, this is also my position on commodities and the position I am invested for. I didn't say I agreed with Gross on everything (I am not calling for a raging bull market, just a slow growth upward trend with the advantage to materials and other products / services consumed by the developing world). I just find his idea of "New Normal" to be self-serving by Gross (as it drives people to bond investments). But I have a hard time disagreeing with the general conclusion of slow growth. BTW...I understand and agree with the points made by "CrashnBurn" regarding the average fund manager, if not the conclusion his handle implies. John Bogle has well-established the data behind these concepts.

Where I disagree with Robert is that a weakening dollar is bad for the American worker. It should be better in the long run as the weaker dollar equalizes the labor cost differentials with America. Also, Chinese labor will gradually get paid higher wages and combined with a stronger relative currency, China will lose its competitive advantage vs. the US worker. This took only 20 years with Japan, but will probably take 50 with China due to its very large size and number of under employed people. I have hope that the Chinese govt will encourage consumption more so than in Japan. If Japan had become the consumer nation its wealth permitted, it wouldn't be stuck in its own downward economic spiral.


On Oct 29 12:32 AM Robert Martorana wrote:

>
> Brian,
>
> I agree with Damienhaas, above: We may see low inflation overall
> in the future, because wages and rents are falling. But commodities
> are headed higher, as emerging markets displace the U.S. as the engine
> of global demand. This is a terrible outcome for most American workers,
> as their purchasing power collapses. Corporate profits, on the other
> hand, will be just fine, as outsourcing cuts costs, and as corporations
> shift their assets to high-growth, high-return markets overseas.
> This disconnect underlies "The Deflation of the American Dream."
> seekingalpha.com/artic...
>
>
> For another view on Bill Gross's latest update, I highly recommend
> Ed Harrison's article:
> seekingalpha.com/autho...
>
> Ed is quite insightful.
> Rob

Oct 29 01:22 AM

[Brian McMorris:]

Well said Past Tense. It is nice to see another quasi-positive person on Seeking Alpha


On Oct 29 12:48 AM Past Tense wrote:

> I for one like the positive tone of your article, I get rather sic
> of the multitude of 'doom purveyors' who appear so wise because they
> make the 'we're all doomed case' with such conviction (Gold bugs
> being the absolute worst). In fact, I always deduct 10 IQ points
> from those types, because its so easy to create fear in others.<br/>
>
> Perhaps Bill Gross is simply talking down expectations of longer
> his term returns, therefore making it easier for PIMCO to out perform
> his gloomy expectations, it's like setting your own exam.
>
> I tend to believe Buffet (who is about the only person on earth to
> get the better of Goldman Sachs) when he said "America's best years
> are in front of us", South East Asia (think America in the 50s) is
> going gang busters with 100s of millions coming into wealth, how
> can the world NOT prosper?
>
> So, what will bring us undone? Don't have yourself on, you like me,
> have absolutely no idea. I tend to think things will get better but
> if they don't then it will be because of something we least suspect
> (otherwise we would've invested in its solution), so stop thinking
> doomsday solutions, put Grandma's gold back in her jewelry box, do
> some trading and kick a football around with the kids this afternoon
> (life's pretty damn good really and a lot better than the alternative)...

Oct 29 01:24 AM

[Peter Mycro...:]

Great Article!

I hope I am wrong but after watching Bill Gross on CNBC yesterday and reading the recent SA articles about him, I think he is frustrated as he knows how dangerous the bond market is right now and how attractive the markets are. He is praying that interest rates will rise so he can make some money for his investors. I think he will underperform the markets for the next three to five years being just a bond house, so that is why PIMCO is moving into equities;

www.themoneytimes.com/...

If Bill really thought equities were overvalued then why is his company pushing hard into that area.

Judge him by what he is doing and not by what he is saying!

Oct 29 10:45 AM

[Bjarne Jensen:]

Brian, I disagree with your statement, "It is never different. The same old story is played over and over. The costumes might change, but the story's the same. " The Post War Baby Boom incrementally changed everything about the economy as it grew. Among first changes was the enormous growth of public education starting with a boom in new grade school construction, then junior high, high school and universities. Followed by a huge demand and growth in residential construction, etc.

The point being that things have been positively "different" for fifty years because of the growth in spending attributed to the post war baby boom. That growth is going to contract as they enter their senior years and spent less and use up what is left of what they managed to save.

So now that their economic influence is negative, things can't be different? I contend they have always been different and will continue to be different this time.

Oct 29 10:46 AM

[Old Trader:]

As I understand it, the whole "New Normal" thing is in reference to what has been viewed as the "normal" return of the "market" returning 10-11% annual returns over longer times spans. What Gross, and others who are like-minded, are saying, is that he's expecting returns to languish in the 6-8% annual returns for quite some time.

Oct 29 11:19 AM

[untrusting ...:]

The most likely push at Pimco is ETF's and index funds with regard to expansion into the equity markets. Some reports from Pimco already indicated this. It really has nothing to do with undervaluation or overvaluation of equity prices at this time, although Bill Gross cleary believes as do many others that US equity prices are overvalued at this point in time.


On Oct 29 10:45 AM Peter Mycroft Psaras wrote:

> Great Article!
>
> I hope I am wrong but after watching Bill Gross on CNBC yesterday
> and reading the recent SA articles about him, I think he is frustrated
> as he knows how dangerous the bond market is right now and how attractive
> the markets are. He is praying that interest rates will rise so he
> can make some money for his investors. I think he will underperform
> the markets for the next three to five years being just a bond house,
> so that is why PIMCO is moving into equities;
>
> www.themoneytimes.com/...
>
>
> If Bill really thought equities were overvalued then why is his company
> pushing hard into that area.
>
> Judge him by what he is doing and not by what he is saying!

Oct 29 11:24 PM

[Brian McMorris:]

This really is the point of this post. All these numbers that are thrown out there (10-11% average return, etc) by writers like Jeremy Siegel, financial planners and brokers, are hand picked to provide a good story. You can come up with just about any "average return" depending on where you start and stop the series you are averaging.

I notice that the typical 10.4%, or whatever, is based on 1930-2000, for example. Well, that is starting at an historical low, and ending at a historical high. That will produce a much better "average" then starting at 1929 and stopping at 2009 (a peak to a trough).

The thing to understand is that there is a very long term "Real Return" that is around 2-3%. It is based on GNP growth, which itself is half population growth and half productivity growth due to improvements in technology. The rest of long term nominal return (the one we see published) is inflation, which averages about 3-4% long term. This is why 6-8% is not a New Normal, but is an old normal. It takes periods of high inflation (6-7% or more) to create averages of 10% plus in markets. Most of us can agree that as we will be fighting deflation for many years to come, high inflation is unlikely. If you argue for high inflation, then you also have to argue for high nominal stock returns (though they can be negative in real return as they were in the 1970s).

It can also be argued that Risk adds to Return. But I am not convinced of that in the long term. I think Risk creates Volatility and in the short term, someone with good investment discipline can take advantage of that volatility by buying low and selling high. That can improve portfolio return. But that is more about trading and less about investing. In the long run, Nominal Market Return is real GNP growth plus inflation.


On Oct 29 11:19 AM Old Trader wrote:

> As I understand it, the whole "New Normal" thing is in reference
> to what has been viewed as the "normal" return of the "market" returning
> 10-11% annual returns over longer times spans. What Gross, and others
> who are like-minded, are saying, is that he's expecting returns to
> languish in the 6-8% annual returns for quite some time.

Oct 30 12:00 AM