Gross says 2% nominal, 0% real

[Lsbcal]

This is for the Federal Funds rate, essentially the 3 month Treasury rate (Tbills). The previous "neutral" rate for Tbills was 4% nominal, 2% real. Now Gross (and others?) are saying maybe we are going to be at 2% nominal, 0% real.

Tough for cash holders if this is the new reality. Bond holders may have to cinch in their belts a bit. Gross doesn't mention how steep he thinks the yield curve will be, i.e. he doesn't discuss what longer dated bonds might go to.

Here is a link to the video: http://finance.yahoo.com/blogs/dail...lar-stagnation-is-here-to-stay-145520100.html

Of course, this is crystal ball gazing. But most of us have to make a bet. My bet is to hold minimal cash.

 

[jebmke]

Makes sense for fixed income. I generally assume between -1.0 and 0% real for fixed low/medium duration and ~4 or so for equity.

 

[NW-Bound]

With the ECB going to negative rate recently, the scenario Gates describes is highly likely.

Outside of I-bonds and stable value funds that I do not want to sell, I still have quite a bit of cash that I need to do something better with. I am thinking about some higher-yielding corporate and sovereign bonds, plus some dividend-paying stocks.

 

[pb4uski]

This is for the Federal Funds rate, essentially the 3 month Treasury rate (Tbills). The previous "neutral" rate for Tbills was 4% nominal, 2% real. Now Gross (and others?) are saying maybe we are going to be at 2% nominal, 0% real.....

So if they previously predicted 4% nominal/2% real and IIRC that did not happen, and they are now predicting 2% nominal/0% real, why would we believe it?

IMO Gross has lost his touch and is milking his past record.

 

[Lsbcal]

So if they previously predicted 4% nominal/2% real and IIRC that did not happen, and they are now predicting 2% nominal/0% real, why would we believe it?

IMO Gross has lost his touch and is milking his past record.

The 4% nominal and 2% real is a historical rough mark, not a previous prediction.

We are free to believe anything, of course. Gross's comments are about the short rates going forward over the next 3 to 5 years. I think these estimates are always revisited as time marches on in a similar way as businesses revisit their future assumptions.

I'm generally more interested in the reasoning behind future assumptions before buying into the future assumptions.

For our portfolio, I've been keeping cash at a low level since 2011. FWIW, I keep 1 year's expenses in short term bonds (VFSUX) and the rest of the FI in intermediate bond funds. So Gross's comments will not really affect my portfolio and are in-line with my assumptions. My assumption is that the Fed and government will encourage risk taking. Short term Treasuries are the lowest risk assets.

Maybe I just like the message as it confirms my biases.

 

[brewer12345]

It is a complete mystery to me why people bother listening to Gross when he talks his book (i.e. says anything in public).

 

[Lsbcal]

It is a complete mystery to me why people bother listening to Gross when he talks his book (i.e. says anything in public).

Since this is a long haul view, it doesn't seem to fall in the short term (talk the book) category. I'd be interested in your long term view as well as Gross's.

Alternate market opinions are interesting to me.

 

[brewer12345]

I've no idea and I pretty much don't care. Rates will do what they will do.

 

[Mulligan]

My financial newsletter would not attract any paid customers, nor should it. But with that being said, I have several CDs maturing this month, and I am throwing in the towel. I am just getting 10 year brokerage CDs at 3.35% at being done with it. When they sent me the letter this week saying they will renew for 3 years at 0.80%, I decided I am cashing them out and moving them to my Vanguard account.


Sent from my iPad using Tapatalk

 

[gcgang]

I've no idea and I pretty much don't care. Rates will do what they will do.

When I was just a lad,
I asked my mother,
What will rates be?
Will they be high,
Will they be low,
Here's what she said to me.

Que sera, sera,
Whatever will be, will be,
The future's not ours to see,
Que sera, sera,
What will be, will be.

 

[NW-Bound]

Just saw on the Web this morning:

In the 12 months through May, consumer prices increased 2.1 percent, the biggest rise since October 2012. That came on top of a 2.0 percent rise in April and was above economists' expectations for a year-on-year increase of 2.0 percent.​

Perhaps the economy is heating up a lot more in the US than in Europe and elsewhere.

My contractor said that the composite siding that he ordered for my garage may not be in for 4 weeks. He initially thought that it was going to be only 2 weeks, but the factory cannot produce it fast enough.

 

[Lsbcal]

I was poking around at the Pimco site and found this explanation by Paul McCulley for the "neutral rate" mentioned in my original post above:

And that assumption became embedded in his ubiquitous Taylor Rule.

Simply translated, his Rule espoused that if inflation was at the Fed’s (then presumed, not explicit) 2% target, and if the economy was at its full employment potential (that is, the unemployment rate was at NAIRU, or the non-accelerating inflation rate of unemployment), then the “right” level for the Fed’s policy rate would be 4% – at-target 2% inflation plus his assumed 2% real rate “constant.”

Yes, that’s the origin of the 4% number that, to this day, the FOMC prints as its “longer-term blue dot” for where the fed funds rate “should be” (if the Fed were, theoretically, pegging the meter on both of its mandates).

link: PIMCO | - Just Give Me a Framework

 

[slazenger]

This is for the Federal Funds rate, essentially the 3 month Treasury rate (Tbills). The previous "neutral" rate for Tbills was 4% nominal, 2% real. Now Gross (and others?) are saying maybe we are going to be at 2% nominal, 0% real.

I didn't watch the video, but is it even that much? My understanding is the starting estimate for a bond's return is its yield, and tbills are in the 0.30-0.35% range at the moment, or thereabouts. For real, you take that rate and subtract estimated inflation rate, and that'll put you at approximately -1.8%.

So sounds to me like Mr. Gross is being optimistic here (or is predicting rates to fall)?

 

[Lsbcal]

You are right about the current situation. See my post just above about neutral rate analysis for past economies. Also one could look up the Taylor rule.


Gross is talking about the neutral rate going forward. We are not yet at the neutral times. still coming out of the nasty recession.

 

[MichaelB]

It is a complete mystery to me why people bother listening to Gross when he talks his book (i.e. says anything in public).

Yeah. "The New Neutral" seems like a PIMCO branding effort. It's very difficult to project economic trends beyond a year in developed countries, almost impossible in the higher growth economies.

 

[NW-Bound]

What Gross said or implied was that inflation rate would run 2% in the next few years, and at first I agreed with him, seeing that the ECB was doing some unprecedented stimulus, and perhaps that meant the world-wide economy was not doing so great.

But then, as I reported in a subsequent post, there are recent signs that the US economy is picking up, and also the accompanying inflation. Today, I talked to my contractor again regarding the delay in getting material for my home repair project. He mentioned that building activity has been picking up in this neck of the wood (literally as we are surrounded by a national forest). A home was just finished down the road from me. And the more expensive homes here are 2nd homes purchased by "weekenders", not by the locals who have more limited income. So, people are spending money again.

Just some anecdotes...

PS. We went checking out a wedding venue (down in the metro area, not this boonies place) with my daughter and her fiance last week. Most places were booked out for this year, and even next spring!

 

[Lsbcal]

Our area seems to be percolating a bit too NW-Bound. There was a report today that homes are up nicely in price, business is doing much better. County and state budgets are getting flusher. Of course, the market knows this as it happens well ahead of newspaper articles.

I think the Fed will let animal spirits emerge (if they are capable of emerging) and tighten only later if really necessary.

 

[NW-Bound]

Here's another anecdote. My contractor has been waiting for a concrete slab to be poured to start a new home, and he said he did not anticipate that wait. He added that his subs were busy, but have not been hiring because they were afraid that all this activity might be just a blip.

Local businesses were hurt bad in 2009, being reliant on "weekenders" to spend money. Now, driving on the nearby highway, I saw that cafes and restaurants were having their parking lot full again.

 

[brewer12345]

Here's another anecdote. My contractor has been waiting for a concrete slab to be poured to start a new home, and he said he did not anticipate that wait. He added that his subs were busy, but have not been hiring because they were afraid that all this activity might be just a blip.

Local businesses were hurt bad in 2009, being reliant on "weekenders" to spend money. Now, driving on the nearby highway, I saw that cafes and restaurants were having their parking lot full again.

In my plebian, middle class corner of suburbia, I have seen a Maserati both today and yesterday (not the same tinypenismobile). Things must be looking up for at least a slice of the population.

I am pretty happy to have an overweight in sectors that do well when things start to heat up.

 

[ejman]

In my plebian, middle class corner of suburbia, I have seen a Maserati both today and yesterday (not the same tinypenismobile). Things must be looking up for at least a slice of the population.

I am pretty happy to have an overweight in sectors that do well when things start to heat up.

Nothing that a good dose of this If Iraqi oil goes off line, $200 oil is next - Outside the Box - MarketWatch couldn't cure.

 

[brewer12345]

Nothing that a good dose of this If Iraqi oil goes off line, $200 oil is next - Outside the Box - MarketWatch couldn't cure.

I have to imagine that demand destruction would limit prices to a good deal lower than that. But if it happened, I have a truck load of oil and gas equities, so bring it on.

 

[MichaelB]

An article in Bloomberg brought this thread to mind. Pimco’s Gross Wagering on Low Volatility in ‘New Neutral’ - Bloomberg Specifically,

Bill Gross is applying Pacific Investment Management Co.’s theory of the “new neutral” beyond bonds, wagering that volatility across markets will remain abnormally low.
“We sell insurance, basically, against price movements,” Gross, chief investment officer of Pimco, said in an interview yesterday in Chicago at Morningstar Inc.’s Investment Conference. “At Pimco, that’s what we’ve tried in the last four or five weeks.”

PIMCO has been forecasting low returns and slow growth for some time. What is new is the low volatility. Two thoughts come to mind.

- In a low returns environment it is critical to have low expenses. PIMCO fees are high, as are many other actively managed funds. Fund managers may now taking on more risk to goose returns, and this may not be evident to investors.

- I recall an interview of Peter Bernstein by Consuelo Mack (Oct 21, 2005). The snippet is below, but his point is highlighted at the end.

CONSUELO MACK: What do you see is the biggest risks in the financial climate today?
PETER BERNSTEIN: There are always a lot.
CONSUELO MACK: Right.
PETER BERNSTEIN: There are always a lot, so just talk about the biggest ones. I think it's the level of debt. In terms of American business, debt is low, and they're in very good financial shape. But households, as we know, are very heavily in debt, and the United States government is very heavily in debt, and in debt to foreigners to an increasing degree, which is a serious problem. It means that we're continuously going to have to produce just to service that debt. The problem with debt is that if something goes wrong in the economy, the debt -- it's like a stiff crust, and if you break it, the whole thing can crumble. Now, this is not a forecast. But you asked me, what are the biggest risks, I think this is where the real risks lie.
CONSUELO MACK: So how do you plan, as a money manager and as an investor, to protect yourself against that risk, that very serious outcome, if in fact, the crust breaks and all hell breaks loose?
PETER BERNSTEIN: Suppose I bet that's going to happen, and make a big bet on it, and I’m wrong.
CONSUELO MACK: Right.
PETER BERNSTEIN: It could be very costly. But it has to be part of your -- of the structure of your decision making. I think there's a time when you have a kernel of securities based on optimistic expectations. By and large, the most awful things don't happen, and then some investments on the outside to cover those extreme outcomes. This is kind of the structure that you use. I don't think you make disaster the core of your investing because if you -- that's a very expensive decision to make if you're wrong.
CONSUELO MACK: Now, you've been an early proponent of the theory that stocks and bonds -- stocks, especially, I think -- are going to deliver low returns. After the terrific returns we saw in the 80s and 90s that essentially we're talking about lower returns going forward. How low, and why do you feel that way?
PETER BERNSTEIN: How low? Who knows? Just not high. One thing bothers me about this view, that there's very little opposition to it.
CONSUELO MACK: And it's not going to be with our other two guests either.
PETER BERNSTEIN: And that's dangerous. But it's very hard to make the case that returns will be, say, after inflation, more than 6% to 7%. That's the most optimistic expectation. We start from a point where we've had a very -- a huge bull market in the 1990s, only part of which has been given back. Equities are still valued at historically high prices. Interest rates, I don't have to tell you, are historically low. And so you start from there, and there you are. I think something very important to think about this, that a period of low returns, you think, well, every year maybe we'll have 4%, 5%. It doesn't work that way. Low returns result from high volatility. You have a big year, and then a bad year, and the pattern of low return periods is high volatility, not low volatility. It's a scary time.

PIMCO forecasts low growth, low returns and low volatility. They are saying "this time is different". Those are scary words.

 

[Lsbcal]

Many are forecasting 5% or so equity growth. Problem is what is the sequence? Some of the infinite possibilities for the next 3 years:

1) 5%, 5%, 5%
2) 10%, 10%, -4%
3) 20%, 20%, -20%

Pick your poison.