Bill Gross Is Bearish On Both Bonds And Stocks, Sees Inflation Stabilizing At 3%

Emerging briefly from retirement, former bond king Bill Gross appeared on Bloomberg TV on Friday for an 18 minute interview, in which said stock and bond bulls are wrong, as both markets are overvalued; he also discussed inflation's impact on investments, suggesting a case for around 3% inflation going forward (as ever more pundits agree with us that the Fed will eventually raise its inflation target from 2% to 3%), adding that the Fed might consider stopping or lowering rates if this level is reached.

The former PIMCO co-founder said the fair value of the 10-year Treasury yield is about 4.5%, compared with the current level of around 4.16%, and pointed out that 10-year yields historically traded about 135 basis points above the Federal Reserve’s policy rate. Of course, the current market - where the 2s10s curve has been inverted for over a year - is anything but comply with historical precedent; still according to Gross even if the Fed lowers interest rates to about 3%, the current 10-year yield remains too low, given the historical relationship.

Gross also believes that the skyrocketing government deficit will add supply pressure on the bond market, and push yields higher.

Siding with Bill Ackman, Gross said that "all of the bulls on Treasuries... I’d think their arguments are a little misplaced. We are going back to proper valuation on longer-term notes and bonds.”

Gross also delved into the significance of higher rates as a sign of a healthy economy and discussed real yields' implications for economic growth and inflation control; he pointed to a potential slowdown in consumption due to rising real rates and the impact of past fiscal programs. Incidentally, the divergence between real rates and Fwd PE multiples has never been greater.

Turning to stocks, Gross was bearish here too and echoed Mike Wilson's favorite regurgitated soundbite saying that the equity risk premium (ERP) - the difference between the earnings yields and bond yields - is at two decade lows, indicating that stocks are too expensive.

Gross also said that he has sold out his holdings of regional banks, after the recent rally and pointing to the changing market conditions. Looking ahead, the former bond king believes that the asset with the “best value” is energy pipeline partnerships, for their attractive high yields and tax-deferred returns.

Full interview below: