Bill Gross: "All Markets Are Increasingly At Risk"

Picking up where he left off last week, when Bill Gross told Bloomberg that U.S. markets are at their highest risk levels since before the 2008 financial crisis "because investors are paying a high price for the chances they’re taking", in his latest monthly investment outlook, the Janus Henderson bond manager says that investors should be wary as low interest rates, aging populations and global warming which inhibit real economic growth and intensify headwinds facing financial markets:

Excessive debt/aging populations/trade-restrictive government policies and the increasing use of machines (robots) instead of people, create a counterforce to creative capitalism in the real economy, which worked quite well until the beginning of the 21st century. Investors in the real economy (not only large corporations but small businesses and startups) sense future headwinds that will thwart historic consumer demand and they therefore slow down investment.

Lamenting the onset of the new normal era, Gross says that "because of the secular headwinds facing global economies, currently labeled as the “New Normal” or “Secular Stagnation”, investors have resorted to “making money with money” as opposed to old-fashioned capitalism when money and profits were made with capital investment in the real economy"

... instead of making money by investing in the real economy, savers/investors increasingly are steered toward making money in the financial economy – making money with money. And that, thanks to nearly $8 trillion of QE asset purchases from major central banks and the holding of short-term borrowing rates near zero or even negative, has made this secular shift in monetary policy extremely profitable.

The biggest hurdle is, of course, record low interest rates: "since cash yields nothing, and in fact depreciates in value day to day given even low 1%-2% inflation, savers/investors exchange cash for alternative choices involving less liquid, longer maturity, and in some cases more risky assets. A bank deposit that earns interest but offers ATM accessibility in measured amounts would be a first step. The available yield – more than 0% but hardly attractive given bank fees and the like – would be a first example of making money with available cash."

Gross' broader point is that - as he has said repeatedly before - capitalism, as we know it, now longer works:

 Zombie corporations are being kept alive as opposed to destroyed as with the Schumpeterian/Darwinian “survival of the fittest” capitalism of the 20th century. Standard business models forming capitalism’s foundation, such as insurance companies, pension funds, and banking, are threatened by the low yields that have in turn, produced high asset prices. These sectors in fact, have long-term maturities and durations of their liabilities, and their assets have not risen enough to cover prior guarantees, so we see Puerto Rico, Detroit, and perhaps Illinois in future years defaulting in one way or the other on their promises to constituents. Faulty finance-based capitalism supported by the increasingly destructive monetary policy begins to erode, not support the real economy.

Gross explains that his point is "that making money with money is an inherently acceptable ingredient in historical capitalistic models, but ultimately it must then be channeled into the real economy to keep the cycle going." However, in a world in which central banks have pumpted $8 trillion in liquidity that is no longer possible, worse as he notes it is only a matter of time before the paradigm of "making money with money" no longer works:

Capitalism’s arteries are now clogged or even blocked by secular forces which when combined with low/negative yielding “safe” assets promise to stunt U.S. and global growth far below historical norms. Ultimately investors must recognize this risk along with increasingly poorly hedged liabilities and low growth resulting from “New Normal” secular headwinds in developed economies. Add global warming to this list, and you have the potential for low asset returns in which the now successful strategy of “making money with money” is seriously threatened. How soon this takes place is of course the investor’s dilemma, and the policymakers’ conundrum.

His advice on how money will be made, "or at least conservatively preserved" in the current environment, is "by acknowledging the exhaustion of “making money with money”. Strategies involving risk reduction should ultimately outperform “faux” surefire winners generated by central bank printing of money. It’s the real economy that counts and global real economic growth is and should continue to be below par."

His conclusion is a familiar one: "don’t be mesmerized by the blue skies created by central bank QE and near perpetually low interest rates. All markets are increasingly at risk."

Full note below:

How to Make Money

 

Because of the secular headwinds facing global economies, currently labeled as the “New Normal” or “Secular Stagnation”, investors have resorted to “making money with money” as opposed to old-fashioned capitalism when money and profits were made with capital investment in the real economy.

 

How is money made with money? Think of it simply as an extension of maturity and risk – all beginning with those $20 or maybe $100 bills in your purse or stashed safely in the cookie jar at home. Since cash yields nothing, and in fact depreciates in value day to day given even low 1%-2% inflation, savers/investors exchange cash for alternative choices involving less liquid, longer maturity, and in some cases more risky assets. A bank deposit that earns interest but offers ATM accessibility in measured amounts would be a first step. The available yield – more than 0% but hardly attractive given bank fees and the like – would be a first example of making money with available cash.

 

But capitalism, or should I say finance-based capitalism, requires more return in order to be profitable for its savers/investors. The next step, for individuals and institutions alike, might be a 6-month CD or a 90-day Treasury bill where yields suddenly approach 1% (at least in the U.S. In Euroland and Japan they are negative but that’s another story). But 1% will not pay the bills for most savers or financial institutions where investors demand compounding returns of 6%, 7% or 8% +, so alternative assets further out the risk/liquidity/maturity spectrum come into play. Corporate bonds, stocks, and private equity are legitimate extensions from non-yielding cash that are part of modern day finance-based capitalism. Savers/investors make money with their money (cash) as long as economies grow and inflation stays reasonably conservative. There is nothing new in all of this, but it helps to outline the fundamental process to understand why today’s economy is so different from that of decades ago and why it induces risks that were not present before.

 

Those differences and risks primarily are a result of secular headwinds whose effects are difficult to observe in the short run – much like global warming. “New Normal” high debt, aging demographics, and deglobalization along with technological displacement of labor are the primary culprits. Excessive debt/aging populations/trade-restrictive government policies and the increasing use of machines (robots) instead of people, create a counterforce to creative capitalism in the real economy, which worked quite well until the beginning of the 21st century. Investors in the real economy (not only large corporations but small businesses and startups) sense future headwinds that will thwart historic consumer demand and they therefore slow down investment. Productivity – which is the main driver of economic growth and long-term profits – slows down. Productivity in fact, in the U.S. and almost everywhere in the developed world has flat-lined for nearly five years now and has increased by only 1% annually since 2000 and the aftermath of the Dot-Com recession.

 

So instead of making money by investing in the real economy, savers/investors increasingly are steered toward making money in the financial economy – making money with money. And that, thanks to nearly $8 trillion of QE asset purchases from major central banks and the holding of short-term borrowing rates near zero or even negative, has made this secular shift in monetary policy extremely profitable. Bank margins have been lowered but their stocks and almost all other stocks have soared here in the U.S. and globally. Investors have discovered that making money with money is a profitable enterprise and have exchanged the support of central banks for the old-time religion of productivity growth as a driver of their strategy. The real economy has been usurped by the financial economy. Long live the financed-based economy!

 

But asset prices and their growth rates are ultimately dependent on the real economy and, the real economy’s growth rate is stunted by secular forces which monetary and even future fiscal policies seem unable to reverse. In fact, as I have mentioned many times in prior Investment Outlooks, monetary policy may now be a negative influence in terms of future economic growth. Zombie corporations are being kept alive as opposed to destroyed as with the Schumpeterian/Darwinian “survival of the fittest” capitalism of the 20th century. Standard business models forming capitalism’s foundation, such as insurance companies, pension funds, and banking, are threatened by the low yields that have in turn, produced high asset prices. These sectors in fact, have long-term maturities and durations of their liabilities, and their assets have not risen enough to cover prior guarantees, so we see Puerto Rico, Detroit, and perhaps Illinois in future years defaulting in one way or the other on their promises to constituents. Faulty finance-based capitalism supported by the increasingly destructive monetary policy begins to erode, not support the real economy.

 

My point in all of this is that making money with money is an inherently acceptable ingredient in historical capitalistic models, but ultimately it must then be channeled into the real economy to keep the cycle going. Capitalism’s arteries are now clogged or even blocked by secular forces which when combined with low/negative yielding “safe” assets promise to stunt U.S. and global growth far below historical norms. Ultimately investors must recognize this risk along with increasingly poorly hedged liabilities and low growth resulting from “New Normal” secular headwinds in developed economies. Add global warming to this list, and you have the potential for low asset returns in which the now successful strategy of “making money with money” is seriously threatened. How soon this takes place is of course the investor’s dilemma, and the policymakers’ conundrum. But don’t be mesmerized by the blue skies created by central bank QE and near perpetually low interest rates. All markets are increasingly at risk.

 

Money will currently be made, or at least conservatively preserved, by acknowledging the exhaustion of “making money with money”. Strategies involving risk reduction should ultimately outperform “faux” surefire winners generated by central bank printing of money. It’s the real economy that counts and global real economic growth is and should continue to be below par.

Comments

spastic_colon Tue, 06/13/2017 - 09:02 Permalink

" How soon this takes place is of course the investor’s dilemma..........."This is every analysts answer right now....translated - "I don't have any idea and needed to publish something"including real in-depth gems like this "............All markets are increasingly at risk."  wow.STFU

Endgame Napoleon buzzsaw99 Tue, 06/13/2017 - 09:54 Permalink

It was a informative article to me and makes total sense, but I would qualify the "aging population" obsession, narrowing the non spenders to a smaller group of those past prime baby-making age.

I owned a small shop, selling custom luxury items, and over the course of selling this luxury item in my own and other shops, waited on thousands of high-profile and upper middle-class customers--from the governor and state reps, to people who were on presidential staffs, to banks owners galore, to famous football players, to famous musicians, to artists who have painted famous people, to umpteen thousands of upper middle-class women who were NOT young.

I hardly ever encountered a young person in the midst of the high womb-productivity years in my own shop or in galleries where I worked. They mostly could not afford the product, not even before the .com bust and during the height of the Bush tax cuts. Since women, primarily in late middle age, not even early middle age, were the main customers, I dispute the idea that money can only be made by catering to youths with high womb productivity.

I am skeptical of the theory that only young customers, having sexual intercourse that leads to reproduction, including the many welfare/taxfare parents who spend millions in welfare and tax-code welfare (taxfare) each year ($96 million in some states) on casinos, out-of-town trips and tattoos, are the only ones capable of spending money and fueling an economy.

I am pretty sure it is just another way to make sure that copulation and reproduction pays more than hard work for the poor and ensures workplace privileges, job slots and retention for the two high-earner couples with kids

I did notice that senior citizens (over age 65) were less frequent customers, though they were more likely to spend money on a custom luxury product than young moms in the middle of the copulation/reproduction phase.

Me thinks the horribly designed ads targeted at middle-aged and older women have something to do with their purchasing zeal or lack thereof--the ones with money, that is.

If I had hurled insulting, depressing ads in faces of my middle-aged customers who were every friggin' bit as "aspirational" about their homes as young moms at the height of fertility, I would not have been able to pay my business loan back. But I catered to them, so I was able to pay my loan back, not getting much for myself from the effort. But I was able to live on what I made from just selling a custom luxury product in a very small, country town with 5 competitors. I used the same approach in city galleries and, likewise, sold a lot.

I do not know whether these ads are just targeted to me by bots, or if Z-Hedge ads are just different, but they are better-designed ads. Most ads aren't unless they are targeting the youth, and can we really say those ads are effective? I do not think so. Millenials are not buying much, either because they have no money in underemployment (mostly likely), just like many (most) Gen Xers, or they are unmoved by the ads.

In reply to by buzzsaw99

Overleveraged_… Tue, 06/13/2017 - 09:21 Permalink

Bill Gross is simply banging the drum, and doing his part to make sure all the bears get SHORT! You see folks, this is no longer hard to tell anymore. The whole point of the markets is:1) Get the Bears short2) Infuse $300+ Billion per month of freshly created dollars3) SKIM the Bears while increasing the value of the assets held by Central Banks.If you can't see what's going on, I don't even think I can convince you. So for what it's worth, I remain Long 3x Leveraged S&P500 w/ year end price target of 3000 and Q1 2019 Price Target of 4500. I have the President's Working Group on Financial Markets, Janet Yellen, Kuroda, Draghi, Gary Cohn and Donald Trump ALL WORKING FOR ME!! There is simply no need to bet against the powers that be. Valuation is no longer true and it's not based on anything except what the price controllers choose to do.Crashes are no longer possible, trade smart people. 

Silver Savior Tue, 06/13/2017 - 09:30 Permalink

Yeah , yeah people keep talking about the risks but they just keep doing basically the same thing. Two markets are undervalued. Crypto currencies and precious metals. It falls under the category of common sense if there is such a thing anymore. People say yeah Crypto had this massive run up and you should sell out now and all this bullshit.I am making the case that crypto does have staying power, is in it's beginning stages, can and should have corrections, is the wave of the future unless everything does go to complete hell, can be used as a store of value (it does not meet the traditional definition but it is appreciating greatly and has more than enough room to keep doing so).The huge amount of fiat currency that is floating around trying to escape negative rates needs to be parked somewhere. Precious metals despite being labeled as non income producing are in my mind in fact an investment, the most important. Precious metals have the obvious qualities of insurance but they also have the ability to increase in value very substantially and it can be at a moment's notice. There may be a time when no metal will be available for for purchase and it will happen quick. I see nothing else out there that comes close. The wild card is how long the current shitshow can be propped up until hyper inflation of the dollar sets in.

Let it Go Tue, 06/13/2017 - 09:30 Permalink

With the markets sporting a glow from all-time record highs that are being made week after week it might be a good time to revisit the concept of irrational exuberance. We must consider the possibility we may be nearing the end of a 37-year run that will completely upend everything most people have come to believe about the economy. Since 2008 all growth has been built on a mountain of debt.Those of us who have doubted and repeatedly predicted the collapse of this so-called recovery remain wrong because we have underestimated both the breadth and size of the global intervention of central banks and governments. Nobody in their right mind would have ever anticipated the sheer magnitude and scope of what has become a worldwide phenomenon. The article below questions when the burden of global debt will cause Atlas to shrug.http://brucewilds.blogspot.com/2017/03/when-will-atlas-shrug-burden-of-global.html

GodHelpAmerica Tue, 06/13/2017 - 09:33 Permalink

GL with financial deregulation Trump. Damned if you do, damned if you don't.

If by someway you are even modestly successful in this regard, blame for the next train-wreck will sit squarely with you. Politics in America...

TradingTroll Tue, 06/13/2017 - 10:11 Permalink

As soon as these Fockers mention global warming that's the sign they are anti humanity.

Like Comey said 'he dealt with many humans over the years'.

Are these figures all reptiles?

/sarc

Harry Lightning Tue, 06/13/2017 - 12:06 Permalink

It sounds like he is having a bad year and already is starting with the excuses. It must be really hard to have to make trading profits when you no longer have the banlance sheet to move the market in your favor.

SeaMonkeys Tue, 06/13/2017 - 14:43 Permalink

Bill Gross is right to identify the problem but he is wrong to say the cause is "secular stagantion." This is what economists like Larry Summers and the New-Keynesians argue. These Democratic economists-the New-Keynesians, and their Republican counterparts like Robert Lucas and Eugene Fama have created the mess we are in.The reason we are in this mess is that we as nation and economy have been subject to excessive rent seeking for too long. The bottom 90% don't have disposable income to spend into the economy because of these 4 main points:1) Land values have been artificially inflated by bank lending for speculation.2) Monopoly power granted by corrupt government has destroyed competition and inflated prices.3) Usury by money lenders in the absence of real wage growth since the 70's has become the norm-credit cards.4) Money creation and economic growth governed not by the collateral value that comes from innovation and good economic/business ideas but rather from the same logic that governs chemistry -specifically colligative properties. What I mean to say is that money is used today as a substance that produces effects and outcomes, and is easily created and destroyed by those that have the power to do so via ex nihilo lending by banks and of course, QE. This is not a productive use of money and leads ultimately to an economy where almost all income is used to pay bills that are inflated due to rent seeking.Explanation of 4 points:1) Land value speculation as a means for quick money by bank lenders, ex nihilo, is addressed by economists like Richard Werner and Paul Craig Roberts' favorite economist, Michael Hudson, among others.Here's a link to Ricahrd Werner's documentary on ex nihilo lending in Japan that resulted in their decades of stagnation:https://www.youtube.com/watch?v=p5Ac7ap_MAYBanks, thru their lending, control the landscape of an economy. Anglo banking has always favored speculation and wealth extraction. 70% of Germany's banks are non-profit and restricted to lending into their local communities. Small and medium sized businesses have acess to credit that results in productive enterprise, not speculative wealth transfers. Germany has 1,500  banks and no history of bank bailouts.2) For a long but good read on the shift in Washington towards embracing monopoly, read a piece by Matt Stoller. It gives a great history of the turn by the Democrats in the early 70's towards embracing monopoly and corporations at the expense of economic populism and the well being of the average American. It also gives a good intro into how the Democratic party also began its pandering towards minorities and use of identity politics as a substitue for good economic policy. Steve Bannon's political/social ideas (4th Turning) starts here, in my opinion, with this betrayal of Americans by the Democratic party.https://www.theatlantic.com/politics/archive/2016/10/how-democrats-kill…) Lack of wage growth in America since the 70's: Outsourcing due to liberalization of capital flows and trade, funding of "Twin Deficits" by debt and the use of the petro-dollar as a means for limitless international need for $'s, Stong dollar resulting from petro-dollar system destroys value adding jobs in America, container ships making transport cheap, and the rise of the investment banks acting as mid-wives for firms in America by turning productive companies here into tradable paper securities. Paper is king in America. The neoliberal establishment, whether Republican or Democrat, has the U.S. military to back it up. Flight to safety is caused by the U.S.3.1) This last point goes back to point #2 and needs expansion: U.S./Eu trade policy towards developing nations has been one where David Ricardo's "Comparative Advantage" rules. You sell us low value added goods like mangos, and we'll sell you high value added stuff like cars. This worked fine for us until we outsourced our value added labor to the developing world. Now they make the value added goods but get paid pennies on the dollar, while the price is jacked up by the monopoly firms and Americans buy it on credit. Destroy the monopoly and lower the price, increase competition. 3.2) The Asian Tigers and Germany were allowed to industrialize because their success would be a good counter measure against communism in the early post war years. They were allowed to allign their banking sector and their industrial sector along the lines of what Richard Werner's video Princes of the Yen calls "Window Guidance." This is where banks target lending to the most productive uses, whether large industry or small businesses.4) We should have sovereign money in America, not private debt money. Theoretically, if all debt were paid off in our economy, approximately 95% of the money supply would dry up since the money supply comes out of the ex nihilo deposits created by loans from banks. Loans create deposits: The Bank of England explains it to the lay person: https://www.youtube.com/watch?v=CvRAqR2pAgwYesterday, ZH posted an article on how so many businesses in America are not able to make a profit.http://www.zerohedge.com/news/2017-06-12/record-wealth-america-72-us-bu… writer was spot on. 20% of the businesses in America account for 80% of the profits generated due to monopoly power while 80% of the businesses in America only generate 20% of the weatlh. These small businesses are the backbone of a country and define who we are as a people. Washington DC and Wall Street are one and the same thing, regardless of which party is in control. Income tax should be zero. Taxes should be on rent seeking only. When people engage in productive activities, they should recieve incentives, not dis-incentives. Income tax is a dis-incentive to porductive behavior and innovation. America's impotent fetish of aristocracy and celebrity have created a population that sheds tears for tabloid personalities that "suffer" emotional trauma from bad hair days while we allow Washigton politicians and their Madison Aveunue spin doctors to convince us to vote against our own economic interests. Readers should read economic history and learn what the 19th century economists debated for 100 years. Rent seeking is the enemy of capitalism. Establishment think tanks and their mouthpieces want you to think that any criticism of the status quo is either Marxist or racist. The use of Marx by establishment mouthpieces is a red herring. Marx is completely irrelevant in today's economy. The establishment will also say that any talk of meaningful economic reform is racist-this is what the Democrats do. They are the current manifestation of the old liberal Republican party of yesteryear. The Democrats are snobby, effetes who are the party of Marie Antoinette. The mainstream Republicans are torn between being fake populists and opposing the effete Democrats to fool the naive Red state voter, or joining the Democrats in the whole-sale rent seeking pillage of America.

ElTerco SeaMonkeys Tue, 06/13/2017 - 16:44 Permalink

Two comments for points (1) and (3):

(1) The capital gains tax law change for homes in 1997 turned homes into an investment vehicle, exacerbating the problem.

(2) Because fewer large corporations are replacing multitudes of smaller businesses, there is now less competition for wages, and more wage-setting. Because of this, all of the income growth has been funneled to the wealthy, with little to no income growth for the majority of the population. Also, yet again, changes to the tax laws in 1995 by FASB SFAS 123 funneled huge amounts of money to the top 1%.

In reply to by SeaMonkeys