Draghi se junta a Bernanke na roda do QE

The Great Escape: Delivering in a Delevering World

Bill Gross, PIMCO

• When interest rates cannot be dramatically lowered further or risk spreads significantly compressed, the momentum begins to shift, not necessarily suddenly, but gradually – yields moving mildly higher and spreads stabilizing or moving slightly wider.
• In such a mildly reflating world, unless you want to earn an inflation-adjusted return of minus 2%-3% as offered by Treasury bills, then you must take risk in some form.
• We favor high quality, shorter duration and inflation-protected bonds; dividend paying stocks with a preference for developing over developed markets; and inflation-sensitive, supply-constrained commodity products.
About six months ago, I only half in jest told Mohamed that my tombstone would read, “Bill Gross, RIP, He didn’t own ‘Treasuries’.” Now, of course, the days are getting longer and as they say in golf, it is better to be above – as opposed to below – the grass. And it is better as well, to be delivering alpha as opposed to delevering in the bond market or global economy. The best way to visualize successful delivering is to recognize that investors are locked up in a financially repressive environment that reduces future returns for all financial assets. Breaking out of that “jail” is what I call the Great Escape, and what I hope to explain in the next few pages.
The term delevering implies a period of prior leverage, and leverage there has been. Whether you date it from the beginning of fractional reserve and central banking in the early 20th century, the debasement of gold in the 1930s, or the initiation of Bretton Woods and the coordinated dollar and gold standard that followed for nearly three decades after WWII, the trend towards financial leverage has been ever upward. The abandonment of gold and embracement of dollar based credit by Nixon in the early 1970s was certainly a leveraging landmark as was the deregulation of Glass-Steagall by a Democratic Clinton administration in the late 1990s, and elsewhere globally. And almost always, the private sector was more than willing to play the game, inventing new forms of credit, loosely known as derivatives, which avoided the concept of conservative reserve banking altogether. Although there were accidents along the way such as the S&L crisis, Continental Bank, LTCM, Mexico, Asia in the late 1990s, the Dot-coms, and ultimately global subprime ownership, financial institutions and market participants learned that policymakers would support the system, and most individual participants, by extending credit, lowering interest rates, expanding deficits, and deregulating in order to keep economies ticking. Importantly, this combined fiscal and monetary leverage produced outsized returns that exceeded the ability of real economies to create wealth. Stocks for the Long Run was the almost universally accepted mantra, but it was really a period – for most of the last half century – of “Financial Assets for the Long Run” – and your house was included by the way in that category of financial assets even though it was just a pile of sticks and stones. If it always went up in price and you could borrow against it, it was a financial asset. Securitization ruled supreme, if not subprime.
As nominal and real interest rates came down, down, down and credit spreads were compressed through policy support and securitization, then asset prices magically ascended. PE ratios rose, bond prices for 30-year Treasuries doubled, real estate thrived, and anything that could be levered did well because the global economy and its financial markets were being levered and levered consistently.
And then suddenly in 2008, it stopped and reversed. Leverage appeared to reach its limits with subprimes, and then with banks and investment banks, and then with countries themselves. The game as we all have known it appears to be over, or at least substantially changed – moving for the moment from private to public balance sheets, but even there facing investor and political limits. Actually global financial markets are only selectively delevering. What delevering there is, is most visible with household balance sheets in the U.S. and Euroland peripheral sovereigns like Greece. The delevering is also relatively hidden in the recapitalization of banks and their lookalikes. Increasing capital, in addition to haircutting and defaults are a form of deleveraging that is long term healthy, if short term growth restrictive. On the whole, however, because of massive QEs and LTROS in the trillions of dollars, our credit based, leverage dependent financial system is actually leverage expanding, although only mildly and systemically less threatening than before, at least from the standpoint of a growth rate. The total amount of debt however is daunting and continued credit expansion will produce accelerating global inflation and slower growth in PIMCO’s most likely outcome.
How do we deliver in this New Normal world that levers much more slowly in total, and can delever sharply in selective sectors and countries? Look at it this way rather simplistically. During the Great Leveraging of the past 30 years, it was financial assets with their expected future cash flows that did the best. The longer the stream of future cash flows and the riskier/more levered those flows, then the better they did. That is because, as I’ve just historically outlined, future cash flows are discounted by an interest rate and a risk spread, and as yields came down and spreads compressed, the greater return came from the longest and most levered assets. This was a world not of yield, but of total return, where price and yield formed the returns that exceeded the ability of global economies to consistently replicate them. Financial assets relative to real assets outperform in such a world as wealth is brought forward and stolen from future years if real growth cannot replicate historical total returns.
To put it even more simply, financial assets with long interest rate and spread durations were winners: long maturity bonds, stocks, real estate with rental streams and cap rates that could be compressed. Commodities were on the relative losing end although inflation took them up as well. That’s not to say that an oil company with reserves in the ground didn’t do well, but the oil for immediate delivery that couldn’t benefit from an expansion of P/Es and a compression of risk spreads – well, not so well. And so commodities lagged financial asset returns. Our numbers show 1, 5 and 20-year histories of financial assets outperforming commodities by 15% for the most recent 12 months and 2% annually for the past 20 years.
This outperformance by financial as opposed to real assets is a result of the long journey and ultimate destination of credit expansion that I’ve just outlined, resulting in negative real interest rates and narrow credit and equity risk premiums; a state of financial repression as it has come to be known, that promises to be with us for years to come. It reminds me of an old movie staring Steve McQueen called The Great Escape where American prisoners of war were confined to a POW camp inside Germany in 1943. The living conditions were OK, much like today’s financial markets, but certainly not what they were used to on the other side of the lines so to speak. Yet it was their duty as British and American officers to try to escape and get back to the old normal. They ingeniously dug escape tunnels and eventually escaped. It was a real life story in addition to its Hollywood flavor. Similarly though it is your duty to try to escape today’s repression. Your living conditions are OK for now – the food and in this case the returns are good – but they aren’t enough to get you what you need to cover liabilities. You need to think of an escape route that gets you back home yet at the same time doesn’t get you killed in the process. You need a Great Escape to deliver in this financial repressive world.
What happens when we flip the scenario or perhaps reach the point at which interest rates cannot be dramatically lowered further or risk spreads significantly compressed? The momentum we would suggest begins to shift: not necessarily suddenly or swiftly as fatter tail bimodal distributions might warn, but gradually – yields moving mildly higher, spreads stabilizing or moving slightly wider. In such a mildly reflating world where inflation itself remains above 2% and in most cases moves higher, delivering double-digit or even 7-8% total returns from bonds, stocks and real estate becomes problematic and certainly much more difficult. Real growth as opposed to financial wizardry becomes predominant, yet that growth is stressed by excessive fiscal deficits and high debt/GDP levels. Commodities and real assets become ascendant, certainly in relative terms, as we by necessity delever or lever less. As well, financial assets cannot be elevated by zero based interest rate or other tried but now tired policy maneuvers that bring future wealth forward. Current prices in other words have squeezed all of the risk and interest rate premiums from future cash flows, and now financial markets are left with real growth, which itself experiences a slower new normal because of less financial leverage.
That is not to say that inflation cannot continue to elevate financial assets which can adjust to inflation over time – stocks being the prime example. They can, and there will be relative winners in this context, but the ability of an investor to earn returns well in excess of inflation or well in excess of nominal GDP is limited. Total return as a supercharged bond strategy is fading. Stocks with a 6.6% real Jeremy Siegel constant are fading. Levered hedge strategies based on spread and yield compression are fading. As we delever, it will be hard to deliver what you have been used to.
Still there is a place for all standard asset classes even though betas will be lower. Should you desert bonds simply because they may return 4% as opposed to 10%? I hope not. PIMCO’s potential alpha generation and the stability of bonds remain critical components of an investment portfolio.
In summary, what has the potential to deliver the most return with the least amount of risk and highest information ratios? Logically, (1) Real as opposed to financial assets – commodities, land, buildings, machines, and knowledge inherent in an educated labor force. (2) Financial assets with shorter spread and interest rate durations because they are more defensive. (3) Financial assets for entities with relatively strong balance sheets that are exposed to higher real growth, for which developing vs. developed nations should dominate. (4) Financial or real assets that benefit from favorable policy thrusts from both monetary and fiscal authorities. (5) Financial or real assets which are not burdened by excessive debt and subject to future haircuts.
In plain speak –
For bond markets: favor higher quality, shorter duration and inflation protected assets.
For stocks: favor developing vs. developed. Favor shorter durations here too, which means consistent dividend paying as opposed to growth stocks.
For commodities: favor inflation sensitive, supply constrained products.
And for all asset categories, be wary of levered hedge strategies that promise double-digit returns that are difficult in a delevering world.
With regard to all of these broad asset categories, an investor in financial markets should not go too far on this defensive, as opposed to offensively oriented scenario. Unless you want to earn an inflation adjusted return of minus 2-3% as offered by Treasury bills, then you must take risk in some form. You must try to maximize risk adjusted carry – what we call “safe spread.”
“Safe carry” is an essential element of capitalism – that is investors earning something more than a Treasury bill. If and when we cannot, then the system implodes – especially one with excessive leverage. Paul Volcker successfully redirected the U.S. economy from 1979-1981 during which investors earned less return than a Treasury bill, but that could only go on for several years and occurred in a much less levered financial system. Volcker had it easier than Bernanke/King/Draghi have it today. Is a systemic implosion still possible in 2012 as opposed to 2008? It is, but we will likely face much more monetary and credit inflation before the balloon pops. Until then, you should budget for “safe carry” to help pay your bills. The bunker portfolio lies further ahead.
Two additional considerations. In a highly levered world, gradual reversals are not necessarily the high probable outcome that a normal bell-shaped curve would suggest. Policy mistakes – too much money creation, too much fiscal belt-tightening, geopolitical conflicts and war, geopolitical disagreements and disintegration of monetary and fiscal unions – all of these and more lead to potential bimodal distributions – fat left and right tail outcomes that can inflate or deflate asset markets and real economic growth. If you are a rational investor you should consider hedging our most probable inflationary/low growth outcome – what we call a “C-“ scenario – by buying hedges for fatter tailed possibilities. It will cost you something – and hedging in a low return world is harder to buy than when the cotton is high and the living is easy. But you should do it in amounts that hedge against principal downsides and allow for principal upsides in bimodal outcomes, the latter perhaps being epitomized by equity markets 10-15% returns in the first 80 days of 2012.
And secondly, be mindful of investment management expenses. Whoops, I’m not supposed to say that, but I will. Be sure you’re getting value for your expense dollars. We of course – perhaps like many other firms would say, “We’re Number One.” Not always, not for me in the summer of 2011, but over the past 1, 5, 10, 25 years? Yes, we are certainly a #1 seed – with aspirations as always to be your #1 Champion.

Viciados em estímulos monetários

Perfeita a charge de uma matéria da The Economist desta semana, com o título "Hit me baby one more time". É o "bull market" capenga, quase morto, à espera de mais uma dose de heroína do Fed. Bernanke, não podemos negar, é um fornecedor animado de droga pesada para o touro machucado. E com os aplausos da esquerda keynesiana, não custa lembrar.

Of Wealth and Incomes

Editorial do WSJ

The Federal Reserve is ending its second round of quantitative easing this month, and Chairman Ben Bernanke was asked recently if he thought the $600 billion in bond purchases had worked. Yes, he replied, because the stock market had risen sharply in value.

Then this week Mr. Bernanke was asked why the economy was lagging. "We don't have a precise read on why this slower pace of growth is persisting," he said, in a rare and revealing case of modesty. Maybe we can shed a little light, and in a way that also explains why so many Americans feel so unhappy about this economic recovery.

Mr. Bernanke was right about stock prices, which as the nearby chart shows (via the S&P 500) began a steady climb following the chairman's QE2 announcement at Jackson Hole at the end of last August. Mr. Bernanke was attempting to promote what economists call "wealth effects," or an increase in spending that accompanies an increase in perceived wealth. Watching their assets rise in value, the argument goes, Americans will consume and invest more.

At least until the recent market correction, this part of Mr. Bernanke's strategy seemed to be going well. If you owned stocks, you had reason to feel better about the economy and your own financial circumstances.

The problem is that monetary policy is not a laser-guided missile. The Fed can create new dollars, but it can't determine where those dollars will flow in a global economy that still runs mostly on a dollar standard. And with QE2 piling on near-zero rates, dollars flooded into assets other than stocks. In particular, they flowed into emerging markets like China and Brazil and into commodities nearly across the board. The nearby chart also shows the trend in oil prices as one example of the commodity price move.

One result has been a sharp increase in food and energy prices that took gasoline up to $4 a gallon. These have produced what economists call "income effects," or a change in consumption resulting from a change in real income. People who pay $4 for gasoline, or $30 more for groceries, have less money to spend on other goods. They also tend to feel poorer, which can influence their overall confidence in the economy.

One big difference is who feels these effects. The wealth effects have helped everyone but especially the affluent. The income effects have been felt most acutely by the poor and middle classes for whom food and energy are a much higher proportion of income. QE2 and near-zero interest rates have been a boon for bankers and hedge funds. They haven't been so great for suburban families who commute to work and haul their kids to football and music practice. The monetary policy so favored by liberal economists and the White House has actively favored the wealthy over the middle class.

Could these income effects have also hurt economic growth by offsetting the wealth effects that Mr. Bernanke likes to take credit for? Mr. Bernanke concedes that oil prices are one of the "headwinds" that have hurt the recovery, so even he is admitting the possibility. The Fed blames rising oil prices on global demand and Middle East turmoil, which have played a role. But we don't think Mr. Bernanke can take credit for one set of rising asset prices but dodge all responsibility for another.

Meanwhile, the flood of dollars into emerging economies has led to inflation and property bubbles that have caused other central banks to raise interest rates or otherwise try to slow economic growth. Since these economies were leading the world out of recession, their slowdown has hurt growth in the U.S. too.

Of late, both stock and oil prices have fallen, no doubt reflecting this slower economic growth and perhaps the end of QE2. Yesterday, the White House tried to reduce oil prices further by orchestrating a world-wide release of strategic oil stockpiles. (See below.) These lower prices will flow to business and consumers, and perhaps they will help Americans feel less gloomy and cause them to spend more once again.

It was interesting to hear Mr. Bernanke say, during his press conference this week, that "as the price of oil declines"—almost as if he knew the oil stockpile release was coming. Mr. Bernanke has predicted that the oil price rise would be "temporary," so he has a reputational stake in seeing them fall as much as the Obama Administration has a political stake.

The larger economic lesson here concerns the sources of long-term growth and the limits of monetary policy. Easy money can help in a crisis, and it can raise asset prices for a while. But it cannot create a durable recovery, and to the extent it leads to bubbles and higher prices it undermines future growth and erodes middle-class incomes.

The real wellsprings of prosperity are private investment and innovation, which Washington has done so much to retard with regulation, the political allocation of capital, and promises of higher taxes. Reversing those policies would unleash a genuine wealth effect.