We’re moving from an era when investors wanted primarily growth and capital gains to one when there is more demand for income, says Bill Gross of PIMCO. These investors want high income but also safe income. In this environment is it important that investment managers get right certain other issues, such as the safety of investments and relative yields. Gross pushes PIMCO “new neutral” theme as the appropriate one to follow. In new neutral, the Fed will hold its federal funds rate near zero longer than many people expect, and this will result in repricing of many assets. In his latest monthly essay, Gross explains what this means primarily for stocks and bonds.
O.K., hopefully I haven’t put you to sleep. My point is that if The New Neutral is closer to 0% real than the Taylor 2% which many expect, then all asset markets, which are priced off of it, are less bubbly than they appear at the moment. P/Es of 16-17x seem reasonable with a 0% real policy rate. 10-year Treasuries at 2.60% do as well once a term premium is added to 2% inflation. Credit spreads themselves, while almost historically narrow, may be using the wrong history book IF Taylor is their guide. At 0% real, high yield spreads of 350-400 basis points make more sense as do other alternative asset yields. Collectively of course, all of these asset prices depend on Janet Yellen’s “not too hot, not too cold” assumption that produces at least 4% nominal GDP growth, but that of course is what Neutral means. Minsky and future Minsky moments have not been outlawed. It’s just that PIMCO believes the New rate is closer to 0% than 2%. If it’s closer to 2%, then bear markets in all asset classes await. We think not.
To PIMCO, this means that asset returns will be low, but less volatile than in prior periods. Perhaps that is why the VIX and Treasury volatility are so low currently. The market may be buying into PIMCO’s view of a slow crawl to a New Neutral. Admittedly, on the other side of the argument, I haven’t even discussed the levered global economy, China, Euroland, or other potential hot spots that might spark another flash crash and mass exodus. There is tail risk in a levered global economy both on the inflationary and the deflationary sides.