Investors: 'Don't Buy What The Fed Is Buying'...Bill Gross

by: John M. Mason


Bill Gross is saying that the Federal Reserve, and other central banks have pumped up asset prices so far that one should not be investing in the things they bought.

This, of course, is counter to the rule, don't fight the Fed, that has brought investors a lot of money over the past several years.

Mr. Gross is arguing that the Fed has now caused so much distortion and imbalance to the financial markets that all that is left for investors are real assets.

Now, we have this advice from a master, Bill Gross of Janus Global Unconstrained Bond Fund.

"I don't like bonds; I don't like most stocks; I don't like private equity."

In a recent interview, Mr. Gross implied that "The things that look good to buy are what central bankers haven't been purchasing." He explicitly stated, "Central banks have not bought a lot of gold. They have not bought real estate to this point."

But, isn't this exactly counter to the mantra that the markets seem to be following up to this point: "Don't fight the Fed."

Throughout the period of recovery, through three rounds of Federal Reserve quantitative easing, investors have gone with the Fed and have done pretty well. The stock market has hit historic highs and interest rates have hit historic lows…with the high bond prices that go with low yields.

But, the financial system is suffering from such a situation. Investable assets may reach a time when they pose too much risk for too little return.

The environment has already caused serious damage to banks, insurance companies, pension funds and individual savers.

And, Mr. Gross added, "Low yields mean bonds are especially vulnerable because a small increase can bring a large decline in price."

He also contends "the financial system won't break down immediately."

But, central banks are running out of tools and central banks, no matter how much their officials claim that they will be reducing their balance sheets, will maintain balance sheets around current levels. There is just no way for the Federal Reserve to really reduce the size of its balance sheet.

The implication here is that central banks, including the Federal Reserve, will not really be raising interest rates soon hoping to bring interest rate levels back into more "normal" territory.

The only solution Mr. Gross sees to this situation is for nominal economic growth to get back to the 4 percent to 5 percent range in the United States, a 3 percent to 4 percent rate in Europe and a 2 percent to 3 percent rate in Japan.

Right now, for the second quarter, the year-over-year rate of growth of nominal GDP in the United States is 2.44 percent.

Real economic growth, year-over-year in the second quarter, was only 1.23 percent.

The US economy is not even close to what Mr. Gross believes it should be to avoid trouble.

The result of not achieving these numbers is that the global economy "devolves into Ponzi finance, and at some point implodes."

In other words, central banks have pumped up financial markets to the point where there is little or no room for further increases. The price increases that have been achieved up to this point have been the result of central bank attempts to create a wealth effect to jump start economic growth.

The only assets that have not been inflated to the point of excess are assets that the central banks have not bought and that limits the investor to things like gold and real estate.

Mr. Gross seems to believe that following the Fed is no longer in rule for the day.

But, he implies that even the prices of these assets will not be able to hold up if nominal growth rates do not return to the levels mentioned above. If this growth does not return then financial markets will build up scheme upon scheme to produce higher yields and this will continue until the system implodes.

Mr. Gross is saying that the financial markets are facing so much distortion and imbalance from central bank operations that without some return to higher "nominal" growth rates, the implosion is only a matter of time.

Not a very happy picture.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.