Is Bill Gross a Tin Hat too?

[RockOn]

PIMCO - IO June 2008


Thanks, to socca in another thread. Didn't want this to be missed. 7% inflation. Fudging of the stats. The distortion on numerous parts of our economy and markets. Hasn't someone been saying that?

I can't wait to hear the dissing of Mr Gross.

 

[HFWR]

His mama!

 

[clifp]

There are several issues here and some missing data. First, I don't think anybody is arguing that Core inflation which excludes food, and energy is a rather useless number for real people planning budget. It does have uses for economist but not for average consumer. As a bond guy, I'd expect Bill Gross to be more of inflation skeptic than the typical Wall St. profession.

The missing piece of data is wage rates in the rest of the world. It is clear that real economic growth has occurred in the developing countries, especially the BRIC nations. Even more dramatically than the US, the folks in China, India, Brazil, other emerging countries are enjoying a better standard of living. If wages in these countries haven't increase substainial faster than inflation, than I think it is likely that folks in the BLS are actually doing a better job in measuring inflation than the rest of the world.

Of course, another possibility is that Rock On and the rest of the tinfoil brigrade set up a fake website and made up the Bill Gross article . See conspiracies work both ways.

 

[brewer12345]

Bill Gross likes to talk his book in public, and the media eats it up. I think it is one of the reasons PIMCO's main fund outperforms. Its like Buffet buying a stake inapublic company and hen seeing the stock fly once the holding is disclosed.

 

[cute fuzzy bunny]

Bill said the Dow would be at 5000 pretty soon, around 7-8 years ago IIRC.

Maybe he'll be right eventually.

Hows that 7% inflation factor into your alleged 6% annuities?

Bill is a very smart guy. But as a bond guy, he benefits by people worrying about a lot of things. So he says things that make people want to worry about a lot of things.

 

[RockOn]

Of course, another possibility is that Rock On and the rest of the tinfoil brigrade set up a fake website and made up the Bill Gross article . See conspiracies work both ways.

Now that's good!

Tin Foil Hats=1
CPI Believers and the Plunge Protection Team=0



Sorry, had to edit... forgot about Ed Hyman, wasn't he economist of the year or something like that for several years?

Tin Foil Hats=2
CPI Believers and the Plunge Protection Team=0

 

[RockOn]

Hows that 7% inflation factor into your alleged 6% annuities?

It doesn't. But 6% safe (? of course) is still better than 4.5% bonds or 4% CD's or 8% High Risk Junk Bonds. Maybe I'll get bro Bill to back me up on that 6% IRR (if I live to mid-80's) annuity number too.

 

[cute fuzzy bunny]

Now if you were only getting that 6% and having it actually be safe in all important regards, you'd be good to go.

So dumb question. You obviously feel like you're being persecuted by people who dont share your view on a number of matters. Whats the big draw in continuing to have the tail pinned to your backside?

 

[RockOn]

Now if you were only getting that 6% and having it actually be safe in all important regards, you'd be good to go.

So dumb question. You obviously feel like you're being persecuted by people who dont share your view on a number of matters. Whats the big draw in continuing to have the tail pinned to your backside?

On the 6%, if I live to 86 in my case, I would be getting a ~6% IRR. I don't know what it would take to prove that to you. Maybe a side-by-side spreadsheet comparison to the returns on a 6% annualized 60/40 portfolio? If when making identical withdrawals they came out to be ~equivalent in portfolio survival duration, would you be convinced of the 6% IRR? Annuities are not safe in all regards, I'll grant you that.

On the second question, it's more challenging to think out of the box, you should try it sometime. I'm just trying to keep you entertained.

I just reread how Bill Gross hit on all of my points. I should have asked him earlier.

 

[d]

if inflation is running as high as he has suggested, then the real return on the funds he manages really s#%ck; don't suppose he has any conflict of interest (pun intended), eh.

 

[socca]

I've been reading Gross' monthly column for quite a few years. Predictions are a dime a dozen and easily ignored; he usually has some objectively verifiable facts that are worth paying attention to. For example, I wasn't aware of the extent to which the algorithms the U.S. gov't uses to calculate inflation numbers deviate from practices used in other countries until I read his most recent column.

 

[RockOn]

if inflation is running as high as he has suggested, then the real return on the funds he manages really s#%ck; don't suppose he has any conflict of interest (pun intended), eh.

He is a bond manager and makes his money off bonds. He has no self- interest in saying inflation is under reported and therefore bonds are overpriced. I'd call him a true American hero.

Maybe the stock market read his article a few days ago?

 

[Independent]

Let's see what Gross says when he actually gets down to CPI numbers.

First, the 1983 change to owner equivalent rent:

... a dubious assumption belied by the experience of the past 10 years during which the average cost of homes has appreciated at 3x the annual pace of the substituted owners’ equivalent rent (OER), and which would have raised the total CPI by approximately 1% annually if the switch had not been made.

Then he talks about the 1990's "Boskin report" changes:

In 2004, I claimed that these revised methodologies were understating CPI by perhaps 1% annually

That's it. So in 2004 he has a total "error" in the CPI of 2%.

To get the first 1% "error", he has to use something other than "owner equivalent rent". If the BLS were simply using house transaction prices in the CPI, then they would be reporting falling prices today and people would be screaming that BLS is cooking the numbers. OER may not be perfect, but any other system, used consistently, isn't going to satisfy the "inflation is horrendous" crowd.

To get the second 1% "error", he needs to say that if people spend about the same amount on a new computer today as they did 12 years ago, the price of computers hasn't gone down. The BLS says that we're buying better computers, therefore they say the price has gone down.

I think the BLS has the right theory on both of these issues. I won't claim that they've got the details perfect. (For example, it's very hard to get "owner equivalent rent" statistics on higher priced homes. Similarly, it's hard to say exactly how much computers have improved.)

Gross also says:

Others have actually tracked the CPI that “would have been” based on the good old fashioned way of calculation. The results are not pretty, but are undisclosed here because I cannot verify them.

He mentions Kevin Phillips, who wrote the Harper's article that's been posted here. As we know, Phillips seemed to get his numbers from John Williams. Williams says that the CPI has been low by 7%, a much bigger number than the 2% Gross is proposing. Probably, Gross "cannot verify" Williams' numbers because Williams won't disclose his calculations.

So when you get down to numbers that Gross is willing to back up, they are modest, and he's not necessarily correct.

Note that I'm not saying there are no clouds on the horizon. Eventually, the international trade issues have to balance out. I'm quite sure that consumer prices today don't reflect $130 barrel oil. If oil simply stays where it is, and the Fed creates enough money to keep nominal wages from falling, we'll see higher consumer prices just from oil working its way through the economy. But those are future events, the CPI is always backward-looking.


P.S. Note that Gross also says:

This isn’t a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it.

 

[Lsbcal]

I like to read Gross's Pimco articles. It does feel like the return rates on TIPS and other US bond rates are too low right now. The 10yr treasury at 3.84% isn't my idea of a good investment. Currently 2yr TIPS and treasuries are predicting something like 2.5% inflation -- does that make sense? Only makes sense if we are going into a recession like 2001. I haven't seen a good explanation for why rates were so low in the 1970's. Could the US bond market be doing a repeat?

 

[RockOn]

Let's see what Gross says when he actually gets down to CPI numbers.

First, the 1983 change to owner equivalent rent:

Then he talks about the 1990's "Boskin report" changes:

That's it. So in 2004 he has a total "error" in the CPI of 2%.

To get the first 1% "error", he has to use something other than "owner equivalent rent". If the BLS were simply using house transaction prices in the CPI, then they would be reporting falling prices today and people would be screaming that BLS is cooking the numbers. OER may not be perfect, but any other system, used consistently, isn't going to satisfy the "inflation is horrendous" crowd.

To get the second 1% "error", he needs to say that if people spend about the same amount on a new computer today as they did 12 years ago, the price of computers hasn't gone down. The BLS says that we're buying better computers, therefore they say the price has gone down.

I think the BLS has the right theory on both of these issues. I won't claim that they've got the details perfect. (For example, it's very hard to get "owner equivalent rent" statistics on higher priced homes. Similarly, it's hard to say exactly how much computers have improved.)

Gross also says: He mentions Kevin Phillips, who wrote the Harper's article that's been posted here. As we know, Phillips seemed to get his numbers from John Williams. Williams says that the CPI has been low by 7%, a much bigger number than the 2% Gross is proposing. Probably, Gross "cannot verify" Williams' numbers because Williams won't disclose his calculations.

So when you get down to numbers that Gross is willing to back up, they are modest, and he's not necessarily correct.

Note that I'm not saying there are no clouds on the horizon. Eventually, the international trade issues have to balance out. I'm quite sure that consumer prices today don't reflect $130 barrel oil. If oil simply stays where it is, and the Fed creates enough money to keep nominal wages from falling, we'll see higher consumer prices just from oil working its way through the economy. But those are future events, the CPI is always backward-looking.


P.S. Note that Gross also says:

Hmmmmm!

Pickin a few peanuts out of the peanut butter are we?

"I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control"

"These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%."

"the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world?"

"just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference."

"The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) hedonic quality adjustments, 2) calculations of housing costs via owners’ equivalent rent, and 3) geometric weighting/product substitution."

"The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress “real” as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields – including TIPS – are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories – bonds, stocks, and real estate – would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

A few of my peanuts.

 

[Independent]

I selected quotes where Gross specified what he thought the BLS was doing wrong, and how much impact he thought the "errors" made.

If you're really interested in my take on these other quotes, I'll try some comments.

"I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control"

I'm not sure if he's talking about the BLS or the Fed here. If it's the BLS, he's not being specific about why he has this opinion.

"These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%."

"the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world?"

He is using a solid piece of economics here. According the the theory of "Purchasing Power Parity", there has to be a close connection between domestic prices and international exchange rates. If there isn't, an investor can make money by arbitraging physical goods. He can buy goods in one country, transport them to another, sell them there, then exchange his currency for a profit.

But this isn't a fast or perfect connection. Not all goods are transportable, it takes time and money to set up such an arbitrage, the investor is at risk that prices will adjust before he completes the deal. So in practice, PPP is just one of the factors impacting exchange rates. The things we read about in the paper - fiscal policy, trade policy, economic stability, and investor's expectations about all these - have big impacts. Gross correctly says that PPP counts "everything else being equal". It's pretty clear that everything else isn't equal in the US right now. He didn't make any attempt to show that we should ignore these other factors.

"The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) hedonic quality adjustments, 2) calculations of housing costs via owners’ equivalent rent, and 3) geometric weighting/product substitution."

The bulk of my post was about these items (numbers 1 and 3 are part of the "Boskin" changes). I picked the quotes with numbers.

"just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference."

"The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress “real” as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields – including TIPS – are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories – bonds, stocks, and real estate – would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

He's talking about why an accurate measure is important to him, but he's not giving any evidence here that the BLS measure is wrong. I do find it interesting that he thinks the market is still accepting "an artificially low CPI". That means all those smart institutional traders, who have access to economists on staff, are blindly following the BLS numbers. If he's right, this means there is still a profit opportunity for people who know better.

 

[clifp]

He's talking about why an accurate measure is important to him, but he's not giving any evidence here that the BLS measure is wrong. I do find it interesting that he thinks the market is still accepting "an artificially low CPI". That means all those smart institutional traders, who have access to economists on staff, are blindly following the BLS numbers. If he's right, this means there is still a profit opportunity for people who know better.

You mean like Annuties? Oh wait if inflation is too low then annuities are even worse deal. I am so confused.

 

[Nords]

Life's too short to bother reading Bill Gross.

He wraps the obvious statements of a Jim Cramer within skills of obfuscation envied by Alan Greenspan.

Funny how most of his answers to current problems consist of "ditch loser stocks, ditch your own loser bonds, buy my winning bond funds".

 

[Maurice]

He mentions Kevin Phillips...

I thought the Phillips plug was interesting. In fact, it made me buy the book - I had read enough about it but the Gross mention was my 'tipping point', so to speak.

I'm 100 pp into it now, I find his data and statistics quite interesting but his arguments less than compelling. I'm not at all unhappy to have bought the book though.

 

[RockOn]

If he's right, this means there is still a profit opportunity for people who know better.

Bingo.

 

[RockOn]

You mean like Annuties? Oh wait if inflation is too low then annuities are even worse deal. I am so confused.

I don't know why this comes up. Annuities are investments like other investments such as stocks and bonds. All investment vehicles are being impacted by the under-reported CPI in my opinion, annuities are not worse off or better off. Annuities are what they are, currently yielding slightly more than some fixed income assets. All fixed income assets get hurt by inflation, with a COLA'd annuity there may actually be some protection. There is no inflation protection on a standard bond investment. (But it really doesn't matter to me if you do not like annuities, I find them to be a pretty interesting non-volatility investment).

PLUS, even though I believe CPI is much higher than reported right now, I am not predicting high inflation far into the future. It could be peaking right now at around 7% (as in the rest of the world) or more, not the 4% CPI-U the BLS is telling us, that's my view.
Using Gross's calculations on the impact of that, many assets could be overpriced; stock PE's in the 20's, the long bond at 4.6%. Both look highly valued historically.

I am waiting for actual inflation to fall from about 7% to 3%. At that point the BLS will be forced to show we are in deflation; the CPI figures will surely go negative, heck the BLS said inflation was zero a few months ago . I predict they will readjust their methods to show there really isn't deflation. Maybe they already have that covered, they will start assuming we are eating steak instead of hamburger again . A panicking Uncle Ben will be flying the helicopter, the plunge protection team at work. It might not be that far off if the housing market doesn't stabilize.

 

[barbarus]

A panicking Uncle Ben will be flying the helicopter, the plunge protection team at work. It might not be that far off if the housing market doesn't stabilize.

House-price deflation is going to accelerate for some time. The only way to stop it would be substantial wage-inflation to make the oversupply of houses affordable to the many. Impossible.

When the Bernanke helicopters release their fiscal payload general-price inflation will also accelerate.

Stagnant inflation.

 

[d]

It could be peaking right now at around 7% (as in the rest of the world) or more

a quick check will show that inflation in the "developed world" is not at the level claimed: Output, prices and jobs | Economist.com

 

[RockOn]

a quick check will show that inflation in the "developed world" is not at the level claimed: Output, prices and jobs | Economist.com

Sorry, but I'll go with Ed Hyman's world inflation numbers. Last I checked, he knows a thing or two about matters like this.

 

[cute fuzzy bunny]

At least someone knows what they're talking about...