Prominent investors are getting worried about inflation and interest rates. Seth Klarman recently told his investors:
There are no easy ways to navigate these turbulent waters. But because the greatest risks are of currency debasement and runaway inflation, protection against a currency collapse – such as exposure to gold – and against much higher interest rates seem like necessary hedges to maintain."
Sharing his concerns about what will happen to bond yields and stock prices, Bill Gross, PIMCO co-CIO/founder, wonders aloud who will buy Treasuries when the Fed stops QE2 at the end of June. He is worried about the fact that the US government may not be able to fund itself when QE2 comes to an end.” This is what he says in his latest monthly outlook:
What an unbiased observer must admit is that most of the publically issued $9 trillion of Treasury notes and bonds are now in the hands of foreign sovereigns and the Fed (60%) while private market investors such as bond funds, insurance companies and banks are in the (40%) minority. More striking, however, is the evidence in Chart 2 which points out that nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns. Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t? I don’t know. Reserve surplus sovereigns are likely good for their standard $500 billion annually but the banks are now making loans instead of buying Treasuries, and bond funds are not receiving generous inflows like they were as late as November of 2010. Who’s left? Well, let me not go too far. Temporary voids in demand are not exactly a buyers’ strike. Someone will buy them, and we at PIMCO may even be among them.
Mr. Gross thinks that there’s a chance that the Fed may be able to successfully pass the credit creation baton to the private sector, but he doesn’t seem to feel so confident about the scenario given that he compares June 30th, 2011 to June 6th, 1944 (D-Day). He concludes that “bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets.” Either way, it doesn’t seem like PIMCO wants to be in the risk game as this unfolds.
Bill Gross seems to be saying that if the Fed continues with the QE policy, it may work for a while longer, but will eventually go the way of all Ponzi schemes and blow up, taking markets with it. If they terminate QE this June, markets may not like that either, especially if geopolitical unrest continues or escalates. Either way, it doesn’t look good for stock or bond markets from his perch.
Bill Gross took a negative tone in his latest piece and PIMCO sees an investment environment that’s fraught with so many uncertainties that they just want to keep lots of powder dry until we see how all of this shakes out:
Investors should view June 30th, 2011 not as political historians view November 11th, 1918 (Armistice Day – a day of reconciliation and healing) but more like June 6th, 1944 (D-Day – a day fraught with hope for victory, but fueled with immediate uncertainty and fear as to what would happen in the short term). Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets. 15% gratuities may lie ahead, but more than likely there is a negative two-bit or even eight-bit tip lying on the investment table. Like I did 45 years ago, PIMCO’s not sticking around to see the waitress’s reaction..
Here you have it. Bill Gross is extremely bearish about bonds and stocks. If Gross is right, we will have a rough June this year as well.
Disclosure: I am long TBT.