Bill Gross: "We See Bubbles Everywhere"
It is only logical that when one of the smarter people in finance warns that he "sees bubbles everywhere" that he should be roundly ignored by those who have no choice but to dance. Because Bernanke and company are still playing the music with the volume on Max, and if not for POMO there is always FOMO. However, if there is any doubt why this "rally is the most hated ever", here are some insights from the Bond King from an interview with Bloomberg TV earlier today: "We see bubbles everywhere, and that is not to be dramatic and not to suggest they will pop immediately. I just suggested in the bond market with a bubble in treasuries and bubble in narrow credit spreads and high-yield prices, that perhaps there is a significant distortion there. Having said that, it suggests that as long as the FED and Bank of Japan and other Central Banks keep writing checks and do not withdraw, then the bubble can be supported as in blowing bubbles. They are blowing bubbles. When that stops there will be repercussions. It doesn't mean something like 2008 but the potential end of the bull markets everywhere. Not just in the bond market but in the stock market as well and a developing one in the house market as well."
As a gentle reminder, the reason why nobody anywhere trusts this particular bubble - the biggest in history - is not because speculators are not greedy (they are), or because everyone knows the market is always one central planner wrong move away from a collapse which would make the 2009 lows seem like amateur hour (it is), but because, as Seth Klarman explained two weeks ago, it is the Fed itself which by pushing on a string and the economy constantly deteriorating, proves it has no idea how to make things better: "When you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed's balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else--even, or perhaps especially, the policymakers—does either."
And today from Bill, on the reason why QE is not working as intended, and why the Fed's channels are not only clogged but never worked as intended in the past four years: "Does it mean it is a good thing that capitalism should thrive under this quantitative easing posture on the part of central banks that distorts markets and this court's capitalism and promotes a zombie corporations and lowers net interest margins and destroys business model? All of that is the negative aspects of quantitative easing. Can we live with? I do not think this will be with us for a long time."
One can hope.
Some other observations from Gross:
On how distorted the bond marker is:
"It is easy on the bond side. We speak to an epical bond/bull market, not the beginning of a bear market but the ending of an epical bond/bull market show it in terms of a smiley face. It has been the investment committee. The bright side of the smile is the thirty year bull market in which prices rose exceeded what rationally could have been expected. We are at the bottom basically of this smiley face and our opinion on a long-term basis. That means with treasury yields and credit spreads, importantly and here is the key to the bond market statement: treasuries are 80 basis points, credit spreads are 70 basis points, put them together, 150 basis points in combination. In our opinion, absent of an additional amount of quantitative easing treasuries will go down in yield because of slowing economy, but that will make spreads go up. This suggests a 20-Month time ahead in which treasury, corporate, and high yields do not move much. The end of the smiley face all market run in terms of higher yields and lower prices is over.
On whether the conditions today are reminiscent of what we saw in 1992 and 1993:
"I do not think so, because in 1994 the FED raised funds dramatically to 200 basis points to basically slow things down. If the FED did that this time, I think they know with this amount of leverage there is two to three times more leverage in this economy this time than in 1994, the FED does not dare move in 200 basis point increments. That kind of market to our way of thinking is not in store for us. Does it mean it is a good thing that capitalism should thrive under this quantitative easing posture on the part of central banks that distorts markets and this court's capitalism and promotes a zombie corporations and lowers net interest margins and destroys business model? All of that is the negative aspects of quantitative easing. Can we live with? I do not think this will be with us for a long time. For the next 12-24, perhaps.
On when the Federal Reserve will start to taper the billions of dollars in bond purchases:
"It is almost a day-to-day thing in terms of the market but certainly not in the terms of the FED. They had objectives in terms of 6.5% unemployment and importantly, 2.5% inflation. We're down to 1 percent inflation in terms of the PCE which is their target for inflationary measure. To think the fed would begin to pull back in terms of tapering when inflation is approaching the Japanese levels of the lost decade is a big stretch. I do not think they change much. I think they have to be concerned about what happens in asset markets. Up until this point the chairman has done an Alan Greenspan and said cannot really relieve him as such but will monitor them in terms of potential regulation. However, having said that, I think the FED basically is on hold for a long time until unemployment and more certainly, inflation moves higher to the 2.5% target.
On the implications of the end of the 30-year bull market in treasury:
"It is not just treasuries. Treasuries, corporates, high-yield. We actually saw the end of the treasury market about six months ago. I think only a few weeks ago when you put the whole enchilada together, what does it mean going forward? It means as interest rates eventually go up, we do not think they are going up for 12 months or so, that the cost of interest for them move forward. And the portly, households will increase as well. Because of the lag effect in terms of the average cost of debt for corporations, and even government, there is a fair amount of room in terms of timing, even as interest rates move back up. Treasury yields on average are above 2%. In terms of what they're issuing it is closer to 1%. Same thing in terms of relative magnitude on the front of corporatations and households. It will be a while until this "smiley face" where higher interest rates begin to affect corporations and the credit sector as well as the government sector in terms of the cost of leverage in the cost of borrowing. Eventually, a net interest margins narrow on the part of corporations because they will hire in terms of interest. Same things for households they pay higher for mortgage loans. That is two to three, four years out. We don't have to worry about it yet, but we have to worry about it.
On the great experiment and what is happening in Japan right now in the shift:
"We want to be able to monitor in the Tokyo office. They are in touch with the institutions in Tokyo. We want to be able to monitor where the money is going. Our sense is not much of it, some of it, is going outside the country. The metaphor for the Japanese small investor, Mr or Mrs. Watanabe, when she or he begins to sense there are more attractive yields outside of Japan and the Japanese Yen moving lower in the yields and lower in price that they can capture a higher total return by moving outside that is where they will go. We want to get in front of them so to speak. Where will they go? Typically they went to the Euro and bought a lot of France and Germany. Those markets we think our extended close to zero. Italy and Spain perhaps at the periphery. And back to the good ol' United States. We think it will buy treasury bonds at 80 basis points above the five-year and close to 1.90 or so for the 10-year treasury. It does not sound like a deal, but a much better field in Japan.
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So to summarize: the great bond bull market is over, but Japan will buy everything about 1.90% on the 10 Year. Perhaps this is why, somewhat counterinuitively, Pimco has been buying up every Treasury it could find in the past 6 months, or around the time Pimco "saw the end of the treasury market about six months ago." Just in case someone takes Bill a little too literally.
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