Contemplating his own demise having turned 70, Bill Gross (MUTF:JUCAX), suggests asset prices could be well past that age in "market years." If so, where is one to turn for returns? "An unconstrained portfolio and an unconstrained mindset comes in handy."
"The successful portfolio manager for the next 35 years will be one that refocuses on the possibility of periodic negative annual returns and miniscule Sharpe ratios and who employs defensive choices that can be mildly levered to exceed cash returns," says Gross, pointing to his recent idea of shorting German Bunds. Yielding around 0%, there's no cost of carry, and a return to 1% or 2% yields is surely inevitable (or not). Modestly levered, it's a 15-20% capital return ... timing uncertain.
"Funny how bonds were labeled 'certificates of confiscation' in the early 80s (the long bond yielded in the teens then)," tweets Bill Gross. "What should we call them now when many interest rates are negative," he adds.
Gross caused a bit of stir last week when he called German 10-year Bunds - then yielding about 10 basis points - the short of a lifetime, even better than the pound in 1993.
The Big Short was Michael Lewis' classic about how some made billions shorting subprime mortgage-backed securities ahead of the financial collapse. Now hedge funder Paul Singer says he's found a bigger short in plain old bonds.
Speaking at the Grant's Spring Conference, Singer wonders "why bondholders persist in trusting that the central banks will be capable of creating just enough inflation and not a farthing more."
Further, why do bondholders believe - as the former Fed chair, now citizen blogger (and now with Ken Griffin's Citadel) has said - that central bankers can cure an inflation overshoot in "ten minutes."
Inflation, says Singer, is already perky if you hang around the same circles he does. "The roaring markets for financial assets, high-end real estate and art, and other things that investors and the rich own or use, should be seen for what it is: a modern and peculiar form of inflation which is sectorial and emerges from a modern and peculiar policy mix. And this is the coming attraction for a more generalized inflation of the future.."
The SPDR DoubleLine Total Return Tactical ETF (NYSEARCA:TOTL) rolled out today by State Street (NYSE:STT) will invest in a broad portfolio of debt securities.
As an active ETF the fund will be managed by veteran fixed income investor, Jeff Gundlach, his team at DoubleLine Capital and State Street Global Advisors.
"DoubleLine obviously brings a history and proven track record of delivering superior risk-adjusted returns,” says James Ross, executive vice president and global head of SPDR ETFs at State Street Global Advisors.
There comes a time, says Gross, when zero-based or even negative yields fail to generate decent economic growth. Yes, we can get rallies in bond prices and P/E ratios, but the effect on real growth diminishes or even reverses. Corporations take advantage by borrowing at low rates, but take the money and buy back stock, rather than invest in the real economy.
What to buy? High-quality assets with stable cash flows: Treasurys and investment-grade corporates, as well as the common stock of companies with attractive dividends and diversified revenue streams.
Oil price drops similar or greater in magnitude than what's recently been seen have occurred a number of times over the past 30 years, say new Pimco CIO Daniel Ivascyn along with Saumil Parikh. Some have coincided with major recessions and others with faster global growth. So what gives for 2015?
The short answer: This drop in oil is supply-, not demand-driven, they conclude, and thus should foster faster economic growth than otherwise next year.
As for inflation, expect negative headline prints in developed economies next year, but these should bounce back later in 2015 and into the following year.
Investment themes: 1) The outlook for easier monetary policy (in all but the U.S.) has been priced in, making for limited upside for high-quality duration 2) TIPS are attractive as their prices have more than discounted the coming negative inflation prints 3) Globally, eurozone peripheral bonds are the pick 4) In the U.S. non-agency mortgages (see Ivascyn's PDI) are poised for outperformance, but agency paper is overvalued, particularly as the Fed's purchases have ended.
Ivascyn also manages the Pimco Income Fund (MUTF:PONAX) and (formerly managed by Bill Gross) the Pimco Unconstrained Bond Fund (MUTF:PUBAX).
"The Fed, as the central banker of the world, has to worry about financial conditions not just in the United States, but the world," Bill Gross tells Bloomberg. "They should be very cautious about any tightening implications."
Gross' comments come as oil crashes, equities and high-yield turn shaky, and the EU debt crisis shows signs of refreshing, and ahead of the FOMC's two-day meeting next week at which many expect the "considerable time" language to be removed from the policy statement - suggesting a rate hike within maybe six months.
"Lowflation" - inflation running at below-target rates - will be the major theme for the next twelve months, says Morgan Stanley's Joachim Fels, presenting his bank's 2015 global outlook. "Markets no longer believe that central banks will be able to bring inflation back to target any time soon. The longer this lasts, the more self-fulfilling these prophecies become."
For evidence, look no further than the U.S. 10-year Treasury yield plumbing new lows on a daily basis (2.17% at last check) despite better economic growth data and promises of rate hikes in mid-2015. Then there's Germany (0.69%), Italy (1.99%), Spain (1.83%), and the U.K. (1.89%).
Taking a variant viewpoint to most in the business, Morgan Stanley sees no Fed rate hike in 2015. As for the ECB, the bank puts the chances of full-blown QE at 50%, up from 40% previously. Easier policy should also be coming from central banks in China, India, and South Korea.
Potential bond buyers are set to spend a net $2.4T next year, but borrowers will issue just $2T, according to JPMorgan. It will be the fifth time in seven years demand has outpaced supply, including about a $500B gap this year.
What's going on here? Central banks. "There's really not been much supply hitting the market," says Nomura's George Goncalves. The ECB is set to buy about $400B in bonds next year, and the BOJ will add at least $700B, says JPMorgan. The BOJ owns about 20% of outstanding JGBs, and that proportion could rise to 50% as soon as 2018, according to the top economist at Japan Macro Advisors.
The quest for yield reaches a new level with London fast food outlet Chilango finding fast demand for its Burrito Bonds, which offer those who invest £10K a free burrito weekly for the life of the debt.
The company is trying to raise £1M for expansion and hit 32% of its target goal two days after the bond opened. Other than the free lunch, the four-year paper has an 8% coupon.
It may not be the top for fixed-income, but "Bond Market Shortfall of $460B Seen Boosting Debt Markets" is the sort of headline you won't see at the bottom. The article from Bloomberg takes note of a JPMorgan analysis expecting debt issued this year to fall $600M from 2013 to $1.8T, while demand increases to $2.26T.
Globally, bonds have returned 3.7% YTD, their best start to the year since 2003, according to the BAML Global Broad Market Index.
"Everybody was expecting supply to come down, but maybe it’s coming down sooner” than anticipated, says SEI Investment's Sean Simko. “There’s a shift in sentiment from the beginning of the year when everyone expected rates to move higher.”
S&P Dow Jones Indices (MHFI +0.4%) expects to unveil smart beta bond indexes in Q4, while BlackRock (BLK +0.3%) doesn't yet have a timetable, but is experimenting with different ways of weighting components of the Barclays Aggregate Bond Index (AGG -0.1%) to make ETFs based on the new indexes, according to the company's Daniel Gamba.
Those issuers with the most debt dominate traditional bond indexes, but smart beta supposedly reduces risk by giving more weight to factors like corporate cash flow, or economic growth rates in the case of sovereign paper.
ETF issuers like iShares hope smart beta funds will lure investors seeking alternatives at a time of worry about higher rates. Smart beta is also more profitable for issuers - Vanguard's Total Bond Market ETF costs $8 in fees for every $10K invested as opposed to a number of smart beta funds charing $50 for every $10K.
Harkening back to the "new normal" thesis peddled by former colleague Mohamed El-Erian for the past few years, Bill Gross (BOND) talks of a "new neutral" to try and explain why 2.50 on the 10-year Treasury is a perfectly reasonable yield.
With debt remaining high and economic expansion continuing to be lame, the "new neutral" real Fed Funds rate is about 0%-0.5%, says Gross, along with Richard Clarida. "If the new neutral policy rate is 0% and the Fed achieves its 2% inflation target, than the 10-year Treasury should trade at close to 2%."
The investment implications: Bubble risk is lower than expected as markets have priced in a real Fed Funds rate of 1-2% and nominal of 3-4% by the end of the decade. If the "new neutral" of 0% real rates and 2% nominal plays out, asset markets could see plenty of support.
Maybe more worried about having cash on hand to meet redemptions than beating their benchmark, bond fund managers have taken cash levels up to 7.6% of AUM at the end of March vs. 3% four years earlier.
Times have changed in fixed-income land - banks have cut thousands from trade desks and shrunk their books of inventory, making it harder for debt managers to exit positions and raising the chance of far more price volatility should there come a rush to sell.
Fund performance is being punished: The broad U.S. bond market up 3.2% this year - the best gains since 2010, according to BAML. Non-traditional bond funds - in which managers have flexibility to decide where to invest - are ahead just 1.7%.