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Bill Gross Your Global Investment Authority
They say defense wins Super Bowls, but the Mannings, Bradys and Montanas of gridiron history are testaments to the opposite. Putting points on the board, especially in the last two minutes, has won more games than goal line stands ever have, even if the scoring has been done by the ﬁeld goal kickers, the names of whom have been conﬁned to the dustbins of football history as opposed to the Hall of Fame in Canton, Ohio. Canton, however, has an approximately equal number of defensive in addition to offensively positioned inductees, so there must be a universally acknowledged role for both sides of the scrimmage line. What fan can forget Mean Joe Greene, Deion Sanders or Dick Butkus? The old, now politically incorrect showtune laments that “you gotta be a football hero, to fall in love with a beautiful girl,” but football and any of life’s heroes can play on either side of the line, it seems.
My point about pigskin offense and defense is the perfect metaphor for the world of investing as well. Offensively minded risk takers in the markets have historically been the ones who have dominated the headlines and won the hearts of that beautiful gal (or handsome guy). Aside from the rare examples of Steve Jobs and Bill Gates, however, the secret to getting rich since the early 1980s has been to borrow someone else’s money, throw some Hail Mary passes and spike the ball in the end zone as if you had some particular genius that deserved monetary rewards 210 times more than a Doctor, Lawyer or an Indian Chief. Nah, I take that back about the Indian Chief. The Chiefs, at least, have done pretty well with casinos these past few decades. Still, the primary way to coin money over the past 30 years has been to use money to make money. Although the price of it started in 1981 at a rather exorbitantly high yield of 15% for long-term Treasuries, 20% for the prime, and real interest rates at an almost unbelievable 7-8%, the gradual decline of yields over the past three decades has allowed P/E ratios, real estate prices and bond fund NAVs to expand on a seemingly endless virtuous timeline. Books such as “Stocks for the Long Run” or articles such as “Dow 36,000” captured
Interest rates have a mathematical bottom and when they get there. Investment defense is coming of age. At the zero bound. Credit Suisse It is Main Street that has failed to keep up with Wall Street and corporate America in the race to see who can beneﬁt more from lower yields. which marks the beginning of the secular decline of interest rates. This transition is not commonly observed. not only are yields rendered impotent to elevate P/E ratios and lower real estate cap rates. although it is relatively easy to prove statistically and even commonsensically. for instance. Insurance companies. Metaphorically. and it shows. “Rinse. While Wall Street and levered investors have fared better than their Main Street counterparts. but there was no sense that the shampoo bottle ﬁlled with money would ever run dry. GEICO. The offensively oriented investment world that we have grown so used to over the past three decades is being stonewalled by a zero bound goal line stand. Prudential or the Met – take your pick – have hired. Well. their legs are cramping.the public’s imagination much like a Montana to Jerry Rice pass that always seemed to clinch a 49ers victory. lather. the washing of the ﬁnancial market’s hair produces a lot less lather when it’s wet. Take for instance the rather quizzical notion that lower yields must produce an equal number of winners and losers since there is a borrower for every lender and the net/net therefore should have no effect on the real economy or its ﬁnancial markets. Low yields. the ability of the consumer to keep up its frenetic spending is reduced. Conceptualize the historical business model of any ﬁnancially-oriented ﬁrm for the past 30 years and you will see what I mean. or property/casualty insurance with more immediate potential payouts. but one where the receivers haven’t been properly hydrated. lather. it’s not as if they’re in “primetime Deion Sanders” shape either. Chart 1 shows that since 1981. whether they be life insurance with their long-term liabilities. priced and 2 INVESTMENT OUTLOOK | MARCH 2012 . instead of fostering capital gains for investors via the magic of present value discounting and lower credit spreads. Yet an instant replay of these past few decades would have shown that accelerating asset prices weren’t due to any particular wisdom on the part of academia or the investment community but an offensively minded Federal Reserve and their global counterparts who were printing money. but they begin to poison the ﬁnancial well. lower corporate proﬁt margins and wreak havoc on historical business models connected to banking. They’re a half step slow. AFLAC. have modeled their long-term proﬁtability on the assumption of standard long-term real returns on investment. repeat” was in effect the singular mantra of central bankers ever since the departure of Paul Volcker. repeat – Rinse. it has. money market funds and the pension industry. advertised. Chart 1 1600 1400 1200 1000 $ bn 800 600 400 200 0 Losing End Personal Interest Income Personal Debt Service Payments ‘80 ‘82 ‘84 ‘86 ‘88 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 Source: Bureau of Economic Analysis. it’s akin to a 4th quarter two minute Super Bowl drill. personal interest income has rather gradually (and now somewhat suddenly) shrunk relative to household debt service payments. and a lot less body after the blow dry. Lower interest rates are having a negative impact on households because their water bottles are ﬁlled with 50 basis point CDs instead of Gatorade. begin to reduce household incomes. Federal Reserve. lowering yields and bringing forward a false sense of monetary wealth that was dependent on perpetual motion. As the interest component of personal income gradually weakens. staffed.
A. Combine A and B along with security selection to seek consistent alpha with admittedly lower nominal returns than historical industry examples. then they begin to downsize in order to stay proﬁtable. Combine A and B along with careful bottom-up security selection to seek consistent alpha. I suppose if I had any common sense I would hold up that clipboard to the front of my mouth like sideline coaches do during big games. PIMCO Defensive Strategy 2012 – ? Ready. whether for hurricane. then assumptions – and practical realities – begin to change. If these ﬁrms can’t cover inﬂation with historical real returns from their ﬂoat. low interest rate environment will require defensive in addition to offensive skills. Hut. Don’t want to chance any of the competition reading our lips to get a heads up on PIMCO’s next offensive play call. Buffett will succeed based upon his continued strong offensive play calling. Set. In the process. Utilize prudent derivative structures that beneﬁt from systemic leveraging – ﬁnancial futures. Buffett’s “Omaha/West Coast” offense is being duplicated around the world thanks to central bank monetary policies. Emphasize income and capital gains. C. A. But then that’s MARCH 2012 | INVESTMENT OUTLOOK 3 . De-emphasize derivative structures that are fully valued and potentially volatile. one to which my investment paragon – Warren Buffett – would probably immediately admit. Hut – 1. Accept ﬁnancial repression but avoid its impact when and where possible. life or automobile insurance. Set. however. Hut 1. Defense! And here’s one of the more interesting anecdotal observations on our current zero-based environment. What does that mean? Well. Recognize zero bound limits and systemic debt risk in global ﬁnancial markets. placing an increasing emphasis on stock and investment selection as opposed to business model liability funding. have long given him a competitive funding advantage over other business models that couldn’t borrow for “free. His business model – and that of Berkshire Hathaway – has long beneﬁtted from what he has described as “free ﬂoat. B. B. PIMCO Total Return Strategy. let’s brieﬂy describe PIMCO’s own historical investment offense for the past 30 years in order to provide a defensive contrast: PIMCO Offensive Strategy 1981 – 2011 Ready.” Today. The downsizing is just another way of describing a transition from offense to defense in a zero bound nominal interest rate world where any almost level of inﬂation produces negative real yields on investment. Hut 2 – 1. Not only insurance companies but banks suffer from this inability to maintain margins at the zero bound.” Those annual policy payments. swaps (but no subprimes!) C. And it seems to us at PIMCO that successful investing in a deleveraging.expensed based upon the assumption of using their cash ﬂows to earn a positive real return on their investment. Hut. The plight of Buffett of course is in some respects the plight of PIMCO or any investment/ﬁnancially-oriented ﬁrm in this new age of the zero bound. they close retail branches that once were assumed to be the golden key to successful banking. So there you have it – the PIMCO playbook. almost any large business or wealthy individual can borrow or lever up with minimal interest expense. Recognize downward trend in interest rates and scale duration accordingly. but the rules of the game are changing. Emphasize income we believe to be relatively reliable/safe. When those returns fall from 7% positive to an approximate 1% negative.
There is no guarantee that the principal amount of the investment will be preserved. interest rates. and are not available to persons where provision of such products or services is unauthorized. Toronto. | PIMCO Australia Pty Ltd (Level 19. credit. No part of this article may be reproduced in any form. strategy or investment product.com or iTunes. | PIMCO Canada Corp. our clients. 2 German Securities Trading Act (WpHG). PIMCO Japan Ltd is a member of Japan Securities Investment Advisers Association and Investment Trusts Association. PIMCO Europe. Italy and Munich Branches are additionally regulated by the AFM. among others. 157591). scan the QR code below. Investing in the bond market is subject to certain risks including market. 363 George Street. PIMCO Europe Ltd services and products are available only to professional clients as deﬁned in the Financial Services Authority’s Handbook and are not available to individual investors. Ltd Munich Branch (Company No. but not guaranteed. ©2012. | PIMCO Deutschland GmbH (Company No. 4 and 9 regulated activities under the Securities and Futures Ordinance. given the importance of informing you. but the defensive line may record more sacks and make more headlines than ever before. 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). PIMCO. 2403 & 2405 Nine Queen’s Road Central. Canada M5H 1T1) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. interest-rate. Canary Wharf. these materials do not set forth speciﬁc fee amounts or their calculation methodologies. Forecasts. PIMCO Europe. Swaps are a type of derivative. or to download recent IO podcasts. Sydney. expert investors and institutional investors as deﬁned in the Securities and Futures Act.720. who should not rely on this communication. 80335 Munich. Information contained herein has been obtained from sources believed to be reliable. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. Investing in derivatives could lose more than the amount invested. Gross Managing Director Past performance is not a guarantee or a reliable indicator of future results. issuer. the investment could suffer a loss. or referred to in any other publication. Tokyo. | PIMCO Asia Limited (24th Floor. 840 Newport Center Drive. Toranomon. All investments contain risk and may lose value. 07533910969) are authorised and regulated by the Financial Services Authority (25 The North Colonnade. Hong Kong) is licensed by the Securities and Futures Commission for Types 1. (120 Adelaide Street West. IO podcasts also available on pimco.com. | No part of this publication may be reproduced in any form. The Amsterdam. without express written permission. | PIMCO Asia Pte Ltd (501 Orchard Road #08-03. Australia). Registration No. Minato-ku. management and the risk that a position could not be closed when most advantageous. market conditions. respectively. the emphasis these days should be on the defensive coach. 24-24a. PIMCO provides services only to qualiﬁed institutions and investors. interest rate. estimates. This material is distributed for informational purposes only. All proﬁts and losses incur to the investor. Investments in foreign currency denominated assets will be affected by foreign exchange rates. 4-1-28. For a behind-the-scenes glimpse into PIMCO. Seidlstr. PIMCO Asia Pte Ltd services and products are available only to accredited investors. CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act. Units 2402. Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Lurgiallee 12. Leveraging has turned into deleveraging. who should not rely on this communication. NSW 2000. 15% yields have turned into 0% money. as I’ve pointed out. Derivatives may involve certain costs and risks such as liquidity. Singapore 238880. of what we are thinking when it comes to investing your hardearned capital. 2604517). Newport Beach. William H. London E14 5HS) in the UK. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction.com . 192083. Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. | PIMCO Europe Ltd (Company No. without express written permission of Paciﬁc Investment Management Company LLC. credit. and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security. offers services to wholesale clients as deﬁned in the Corporations Act 2001. IO116-011712-GBL Newport Beach 840 Newport Center Drive Newport Beach. Go ahead competitors and read our lips.382. and PIMCO Europe Ltd . The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as deﬁned in Section 31a para.6000 Amsterdam Hong Kong London Milan Munich New York Singapore Sydney Tokyo Toronto Zurich pimco. Ltd Amsterdam Branch (Company No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt ﬁnancial adviser. The value of assets ﬂuctuate based upon prices of securities in the portfolio. The Super Bowls of the future will have their Mannings and Bradys. AFSL 246862 and ABN 54084280508. They are not available to individual investors. This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. while some swaps trade through a clearinghouse there is generally no central exchange or market for swap transactions and therefore they tend to be less liquid than exchange-traded instruments. we’ll just pound that pigskin down the ﬁeld anyway. and inﬂation risk. or that a certain return will be realized. Suite 1901. Besides. market. or referred to in any other publication. Ontario. The fee charged will vary depending on the investment trust acquired or the investment advisory agreement entered into. CA 92660 +1 949. and credit risk. CA 92660 is regulated by the United States Securities and Exchange Commission. | Paciﬁc Investment Management Company LLC. and BaFin in accordance with Section 53b of the German Banking Act. | PIMCO Japan Ltd’s (Toranomon Towers Ofﬁce 18F.never been my or Mohamed’s style.Italy (Company No. 24319743). 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