The PIMCO Maestros: Bill Gross and Mohamed El-Erian on the Economy

Bill Gross is out again with a no holds barred punch at the administration and the current state of affairs. He predicts a trillion dollar deficit for the next administration, and a severe inflationary uptrend.

I had linked to his earlier excellent missive and CNBC appearance here. There’s also a discussion where I speculated that a mean reversion in the price-earnings multiple to ~12 could be the fat tail PIMCO is watching out for.

It’s good to see wide media coverage for both Bill Gross and Mohamed El-Erian. I'm generally a fan of fixed-income strategists. While Gross has a nice straightforward way of assessing things, El-Erian's measured tone makes him very interesting to watch or read.

I’m currently reading El-Erian’s "When Markets Collide," and it’s been a gripping read so far. His analysis on the current situation is really thought provoking. I think this is shaping up to be one of the must read books of the year, especially to understand the current situation and the shape of things to come. (Think Taleb’s "The Black Swan" in 2007).

You can read the reviews from this Amazon link to pique your interest and an introduction to the book can be found on PIMCO’s website.

An excerpt from the introduction follows:

A series of inconsistencies and anomalies, which will be detailed throughout the book, acted as early signals of the growing tension between what participants or actors on the global finance stage were pressing for and what could be reasonably and safely accommodated by the existing systems in order to minimize the risk of turmoil.

Market participants first become aware of transformations through what is commonly known as “noise.” This noise comes initially from the sudden emergence of anomalies to long-standing relationships that participants take for granted. Noise can matter in so far as it contains signals of fundamental changes that, as yet, are not captured by conventional monitoring tools.

For what seemed an eternity for investors (many of whom feel that a week is a long time), the U.S. bond market provided signals about the economy that conflicted with those coming out of the other most liquid market in the world, the U.S. equity market.

This inconsistency was accompanied by a rather peculiar situation among Fed watchers, that group of economists and analysts on Wall Street who make their living from predicting the course of the most influential interest rate in the world—the fed funds rate. In the middle of 2006, with the rate at 51⁄4 percent, the vast majority of Fed watchers fell into two distinct and opposite camps. One confidently predicted rate hikes—to 6 percent; the other equally confidently predicted cuts—to 4 percent. I remember noting several times that I could not recall such divergence in sign and size among such credible market observers.

Hmm.. Don’t we have a similar situation right now? Market strategists and economists seem divided between whether interest rates are headed up (read PIMCO's missive) or down (eg. Gary Shilling). There's even a divergence between countries cutting or raising interest rates. Is this signal telling us something? The current divergence could be hinting at the shape of things to come over the next year or so. It's all about observing signals in the noise.

My two cents is that yields would probably come down in the next year in a deflation scare, before treasuries enter a decade long bear market. Even Hussman extended bond duration a few weeks back. PIMCO’s investment thesis, while right in the long run, could underperform this year.

Full Disclosure: None

Comments

[bluesmoke]

Although I'm lousy at forecasting, I have found much solace in the words of Bill Gross. I believe his insights ring with the most truth. In a time of severe media noise, Bill's willingness to stand up and be heard are admirable traits.

[Whidbey]

Sort of a literary review? Do you have any basis for believing that deflation is a threat without a concurrent major economic dislocation? Unemployment at 8-10%, CapEx at 50% of 2007, Personal savings < 0. What might occasion such a dislocation? National debt levels in the USA? A president and Congress that see few or no expenditure limits. The assumption that tax yield is not income elastic. Yes Pimco might see a P/E of 12 as a target, or one of 8, if the tax cuts of the past few years are allowed to expire and Cap gains taxes pushed back to 35-38%, stimulus expenditures (bailouts) become prominent policy actions. It does not take a sage to speculate just some willingness to discuss the facts, if you know them.

[Sajal]

Whidbey,

I really liked your points.

I'm just trying to point out that the opinions of experts are divergent on this issue, exactly what El-Erian calls for watching out in his introduction. There are excellent reasons why both sides could be right(like the fiscal stimulus should be inflationary).

Also note that I only mentioned a 'deflation scare' (like we had a few years earlier)(I admit it sounds very improbable right now) . The last para was just my opinion, and should be taken as such. The main reasons being the loss of the wealth effect, declining commodity inflation, slowdown in emerging economies, housing wealth destruction etc. Yields could also go down in a flight to safety. It's quite possible that I could be wrong. Hey, so would half the experts!

[icandoitdon]

i've got great respect for gross and i agree with his analysis of the screw ups of the last 8 years that got us to our current hapless state. but that's where we part company.

gross acknowledges ponzi style schemes (his words) of cheap credit and lender-of-last-resort bailouts to keep our economy growing and what does he offer up? bailouts for homeowners in the form of direct subsidies and/or absurdly low interest rates and more stimulus checks to replace the contration in consumer spending that we're nowbeginning to feel.

and we're still "officially" not even in a recession. makes you wonder about the veracity of all that government data doesn't it?

there was a time when our economy was strong enough to handle economic downturns. no more, i guess. that suggest to me that we have structural flaws that the same old snake oil won't cure and aren't going away any time soon. that bodes ill for investors in u.s. securities and the u.s. dollar.

and what gross recommends isn't going to change a damn thing.

[CES]

Paul Volker is an Obama supporter and advisor, Doesn't that tell you something??

Check it out.