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| Founded in 1971 by Bill Gross, with $12 million in assets under management, PIMCO - - Pacific Investment Management Company - - today it is the biggest bond fund manager with about $756 billion in assets. In 2000, PIMCO was acquired by German insurance giant Allianz.
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Bill Gross, the founder of multi-billion dollar bond fund manager PIMCO, says in his July Investment Outlook, that greed will come again. But for now, the trend is the other way and it promises to persist for a generation at a minimum.
In an article published on Wednesday, Bill Gross' colleague Richard Clarida, highlighted the remarkably tight correlation in the United States between the total outstanding stock of credit extended to the private non-financial sector, with the level of nominal GDP, from 1952–1984.
"Given the stability of this relationship for the 30 years ending in 1984 – through two wars, the great inflation, the breakdown of Bretton Woods (I) – it is startling to see the chasm that emerged between credit outstanding and nominal GDP since then," Richard Clarida says.
He says, of course, debt levels are supported not only by income - - as measured by nominal GDP - - but also by asset valuations themselves. Indeed, throughout the great credit boom, household net worth rose to record levels, hitting $64 trillion in 2007 (up from a mere $12 trillion in 1984).
Clarida says with household asset values rising faster than debt, debt appeared to be sustainable. As a result, too few questions were asked for too long by too many (and he didn’t exempt himself) about the implications of this surge in non-financial leverage, which, at least in retrospect, was itself the source for much of this asset price appreciation. (Hyman Minsky emphasized this point in Stabilizing an Unstable Economy (1986)). He says analysts, investors and policymakers just presumed that with inflation tame and GDP growing reliably along its “great moderation” path, the widening chasm between private credit and nominal GDP could be ignored, much as the breakdown in the relationship of the velocity of the monetary aggregates to GDP growth was ignored. Indeed, this presumption became embedded in the econometric models that academics used to analyze monetary policy: The quantity of money in circulation or the quantity of credit extended to the private sector does not even appear in those models.
In the US in 1984, $3.5 trillion of nominal GDP supported $3.5 trillion of private credit outstanding. By 2007, $14 trillion of nominal GDP supported $25 trillion of private credit outstanding.
Clarida says the surge in leverage did not put upward pressure on inflation because the financial globalization that occurred during the past 25 years and, more recently, the global savings glut opened up a huge global market for US fixed income securities. These bonds were dollar denominated, and with the dollar the global reserve currency, they enjoyed privileged access in global portfolios. As a result of this inflow of foreign capital, the US was able to finance record and ever-rising current account deficits.
Bill Gross says in his Investment Outlook, that the supersizing of financial leverage and consumer spending in concert with the politicizing of deregulationdescribes in fifteen words our most recent brush with irrational behavior and inefficient markets.
He says greed will come again. But for now, the trend is the other way and it promises to persist for a generation at a minimum. The fact is that American consumers have suffered a collapse in wealth of at least $15 trillion since early 2007. Global estimates are less reliable, but certainly in multiples of that figure. And when potential spenders feel less rich by that much, the only model one can use to forecast the future is a commonsensical one that predicts higher savings, lower consumption, and an economic growth rate that staggers forward at a new normal closer to 2 as opposed to 3½%. There’s no magic in that number, and no model to back it up, just a lot of commonsense that says, this is how people and economic societies behave when stressed and stretched to a near breaking point.
Gross says he was impressed by a recent article in the Op-Ed section of The New York Times by staff writer Bob Herbert. “No Recovery in Sight” was the heading and his opening sentence asked, “How do you put together a consumer economy that works when the consumers are out of work?” He says that is really all one needs to ask when divining our economy’s future fortune. Unless an optimist can prescribe how to put Humpty Dumpty back together again and shuffle him/her back to work then there can be no return to an “old normal.” As unemployment approaches 10%, what is less well publicized is that the number of “underutilized” workers in the US has increased dramatically from 15 to 30 million. Those without jobs, as well as those individuals who only work part-time and have become discouraged and stopped looking, total 30 MILLION people. The number is staggering. Commonsensically, Bill Gross says one has to know that many or most of these are untrained for the demands of a green-oriented, goods-producing future economy. Imagine a welding rod in the hands of an investment banker or mortgage broker and you’ll understand the implications quicker than any economist using an econometric model.
Gross says what this all means to an investor is near obvious as well. Unsurprisingly, what still can be modeled is the direct correlation of real profit growth to real economic growth, assuming a constant division of the “pie” between profits, labor and government. If long-term economic growth declines by 1½% then profit growth will as well. This, after settling at perhaps half of absolute peak profit levels of 2007, because of the rise of savings rates from 0 to 8% or higher. But to add to the woes of the investor class, one has only to observe that their share of the pie is shrinking. He asks: What does the General Motors example tell us all about the rebalancing of power between the investor class and the proletariat? What do trillion-dollar deficits and the recent reinitiation of PAYGO government programs tell you about the future of corporate tax rates? They’re headed higher. Do you really think that a national health care program can be paid for with cost-cutting as opposed to tax hikes at insurance companies and benefit-paying corporations throughout all sectors of the American economy? Bill Gross says the new normal will not be investor-friendly unless your forecasting dial is turned to “Pollyanna” or your intelligence quotient is significantly less than 100.
Investors who stuffed themselves on a constant diet of asset appreciation for the past quarter-century will now be enclosed in a cage featuring government-mandated, consumer-oriented fasting. “Non Appétit,” not Bon Appétit, will become the apt description for the American consumer, and significant parts of the global economy, including the US. Because this is so, short-term policy rates will be kept low for longer than cyclical norms, and the outlook for risk assets - - stocks, high yield bonds, and commercial and residential real estate will involve just that - - risk. He says investors should stress secure income offered by bonds and stable dividend-paying equities. Consumer Cuisinart consumption is a relic of the past.
