Investors need to accept the fact that ‘the game as we have all known it appears to be over’, says US investor Bill Gross. The co-founder of the world’s biggest bond fund, PIMCO, reckons that investors need to change their strategies in the wake of the financial crisis.
To understand how different things are now we have to look at the history of leveraging, before the financial crisis, says Gross. Since the early stages of the 20th century ‘the trend towards financial leverage has been ever upward’. Politicians set the rules, by relaxing regulation and freeing paper currency from real world constraints like gold.
Meanwhile ‘the private sector was more than willing to play the game, inventing new forms of credit, loosely known as derivatives’. The ever-expanding credit had a profound effect on investing attitudes, says Gross. ‘“Stocks for the long run” was the almost universally accepted mantra, but… for most of the last half century [it was] “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.’
Investors became used to the idea that extra leverage would push up the value of financial assets in the future. ‘P/e 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.’ In effect, wealth was ‘brought forward and stolen from future years’, says Gross.
The New Normal
But growth expectations ‘exceeded the abilities of global economies to consistently replicate them’. The crash came and now some countries and economies are trying to pay off debt instead of adding more. Globally credit is still going up but far more slowly than before.
The result is ‘negative real interest rates and narrow credit and equity risk premiums; a state of financial repression… that promises to be with us for years to come’. In this “new normal” ‘real growth as opposed to financial wizardry becomes predominant’. But achieving that growth is made more difficult ‘by excessive fiscal deficits and high debt/GDP levels’, says Gross.
So what does that mean for investors? Gross reckons that in the “new normal” commodities and “real” assets will be the star performers. If you are going to go for financial assets then pick those that pay back quickly. So for bonds ‘favour higher quality, shorter duration and inflation protected assets’. And if you want shares look for dividend payers, rather than the longer-term promise of growth stocks.
James McKeigue
Contributing Writer, MoneyWeek
Publisher’s Note: This article originally appeared in MoneyWeek (UK)
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