Bill Gross, the $747 billion bond man, declares the death of equities
Filed under: Economy, People, Investing
Stocks are dead for the rest of your life. That's the gist of my exclusive interview with the head of PIMCO Total Return -- the biggest bond fund you've never heard of. But you should know PIMCO because its chief, Bill Gross, is one of the world's most powerful bond investors.
Last September it looked like he was "helping" the U.S. government by advising it to put Fannie Mae and Freddie Mac into conservatorship. While this wiped out stockholders, Gross's Fannie/Freddie bonds were boosted by the U.S.'s decision. In addition to running a $747 billion asset management firm, Gross's PIMCO advises the U.S. on its $251 billion commercial paper program and its $500 billion fund to buy mortgage-backed securities. Gross shared his economic outlook with me yesterday in an exclusive interview -- and he's not optimistic.
I've never met Gross so it came as a complete shock when I received an e-mail from him yesterday morning. I was quoted in the latest issue of Fortune suggesting that he might be too powerful for the U.S.'s good. How so? Because he's such a big buyer of government debt -- which it's selling in huge quantities to finance various bailouts -- that he could use his leverage to threaten to walk away unless the U.S. sells to PIMCO at a favorable price.
On Monday I gave a TV interview in which I suggested that the U.S. might consider avoiding this potential problem by giving PIMCO's advisory contracts to another firm that does not have the potential conflict between buying U.S. debt and advising the government.
Gross saw the interview and e-mailed me. I replied by telling him that I had some questions about PIMCO and his views on economic prospects. I found his answers informative and insightful and he agreed to let me post on his economic outlook which is very grim for those who believe that stocks outperform bonds. In Gross's view, the current economic contraction is killing the animal spirits that drive risk taking and that's contributing to the death of equity capitalism as we've come to know it.
As Gross told me, "things will never be the same. Risk taking has been destroyed and any animal spirits must come from Washington. Global growth rates -- low, low, low -- asset classes will be readjusted for that outlook. That is -- stocks will be more of a subordinated income vehicle as opposed to a 'stocks for the long run' growth vehicle."
This argument is great for bond fund managers such as Gross since it would tend to drive people out of stocks and into bonds. But his point about stocks as a subordinated income vehicle is interesting. If I understand him correctly, he views stocks as the bottom of the liquidation hierarchy -- meaning that if a firm files for bankruptcy, all the other stakeholders -- such as bondholders, lenders, and preferred stock holders -- get their money before the common shareholders see a dime.
This is why so many common shareholders are getting wiped out. And in Gross's view, growth prospects are so dim that there is no point in owning stocks since common stock investors will not benefit when there's no economic growth. Moreover, they'll be last in line for any dividends that might be available.
Meanwhile, Gross has an interesting analysis of how we got into this mess. He attributes it to too much borrowing, weak regulation and greed. He also thinks that the U.S. is going to have to come up with as much as $5 trillion to fill the capital hole in the banking system.
As Gross said, "The cause of the current situation was too much leverage leading to over consumption which was facilitated by lax regulation and good ol' fashioned greed. Human nature will never change but our institutions will. Not sure policymakers understand what needs to be done -- there still is a $4 trillion to $5 trillion capital hole that needs to be filled but politics may inhibit necessary action. Bernanke and Co. get it though and have more freedom and flexibility -- they are independent -- for now."
These are sobering thoughts from one of America's most powerful financial minds. My hunch is that over the medium- to long-run, we'll revive capitalism through venture-backed technology innovation. But I am not sure how soon that will happen. Meanwhile, what do you think of Gross's comments? Do they make you want to sell stocks?
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He has no financial interest in the securities mentioned.
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Reader Comments (Page 8 of 8)
2-28-2009 @ 7:59PM
spigzone said...
In early summer, 2006, the local librarian ordered Matthew Simmons' 'Twilight in the Desert - the coming Saudi oil shock ... " seeing only the first part of the title on an Amazon top ten list and thinking it was a romance novel for her mainly female clientele. I wandered in, saw it, grabbed it and 36 hrs. later I was sitting stunned in my living room. I immediately cancelled my subscription to The Economist (who had just declared oil in plenty for 40 years), liquified my stock and bond holdings and started preparing for what was essentially going to be an energy armegeddon starting in earnest in 2008 and going downhill from there. This elevator ride is just starting folks.
The odd thing is the continuing decline in oil supplies, temporarily hidden by the demand destruction from the economic implosion, seems to be off the radar of all the leading economic blogs. When that decline comes out the far end of the demand destruction, sometime late this year or early 2009 - well, that's when you're going to start seeing some REAL panic. What'shappened so far is just a taste of what is to come. Think 50% decline in world GDP by the end of 2015. PERMANENT decline.
I have surely learned it is the rare rare human that has to courage to face what IS, no matter how terrifying. 95 out of 100 just refuse to even LOOK at the data. They just don['t want to hear it, they want things to go on AS THEY WERE.
Which is what President Obama is facing, I suppose, and why he is taking the approach he is. But the physical reality is unrelenting and utterly pitiless. The populace of this country is, in their collective heart, soft cowardly pussies, which is how Bush could leverage 19 men armed with box cutters into a multi-trillion war on terror and commit grand theft country and argue in the Supreme Court for the right to arbitrarily imprison without recourse anyone at all, even US citizens, with the cast bulk of the people turning a blind eye and deaf ear.
This country is soooo screwed.
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2-28-2009 @ 10:13PM
Jeff said...
I'm 30 years old and use to work on the floor of the American Stock Exchange in the options pit. I have a bachelors degree in Economics. My inclination is to say that stocks pose an opportunity for one hell of an investment right now. Price to Earning ratios are around historical averages. Dividend to Price ratios look attractive. I think the most interesting thing about this crisis is that it shows how dependent we are upon the financial sector. Wipe out the financial sector and you wipe out leverage and the animal spirits / risk taking behavior Gross talks about. If you consider the size of the blow we just took the negativity should come as no surprise. The US housing stock is worth approximately $30 trillion dollars. It lost 20% of its value from the peak. A nice $6 trillion dollar loss. Consider half of that wealth was equity the other half debt. $3 trillion dollars in debt market losses. Let's not forget what is happening. The financial sector's equity has been completely wiped out. Let's look at whats been wiped out with it. Hmmmm all leverage in the financial markets. My guesstimate is that the government will nationalize the remaining big banks... JP Morgan, Citi, Wells Fargo, and Bank of America. After that shoe has dropped and the massive debt hole filled, I suppose we can get back to our business of re-levering the markets. I'm sure it is going to take some time. But I think the acute nature of this crisis, has left some real opportunities.
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2-28-2009 @ 10:18PM
Rod said...
Mr. Gross's comments make me more convinced the bottom is near and he is scared sh&tless. Once this economy starts to come back (and it will) the coming inflation is going to wipe him out. Do you believe the world is going to lay down and die, stop eating, stop producing and consuming? We are in the middle of the largest population boom the world has ever seen. With nearly 200 million humans born each year there is going to be alot of consumption going on. Bankers just need to get their heads out of their asses if they want to survive and start lending money...only wisely this time.
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3-02-2009 @ 12:22AM
antone said...
the feral reserve drives the economy like a drunk on a country road....from one ditch to the other. They will REFLATE the economy at all cost, namely the USD. The currency is dead. The political structure of this country will soon be dead as well if they can't reflate. Re-flation will cause equity, real estate, commodities, etc. to rise again even higher. You better own something tangible when this happens. If you dont you will be slaughtered by inflation.
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3-02-2009 @ 12:53PM
EQ said...
Interest on debt is paid with the excess returns of equity. If a firm provides returns to debt in excess of the returns to equity, it has no raison d'etre. It becomes the beast that devours itself by first nibbling at its tail.
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3-04-2009 @ 4:33PM
jimstep said...
The bailout, stimulus plan and deficit spending will not succeed because Govt officials and economists do not understand the problem. The basic problem is too much debt built up over 25 years. YOU CANNOT SOLVE THE PROBLEM OF TOO MUCH DEBT BY ISSUING MORE DEBT.
Pres.OBama's new Stimulus Plan will flood the bond market with a wave of Treasuries securities. Later, when investors (including China,Japan, Arabs) perceive that US cannot pay all the interest and principal, investors will not buy the Treas. bonds. Then, the value of Treas bonds will fall, and interest rates and taxes will soar. Worse, if Fed Reserve resorts to printing too much money ("monetizing" the debt") it will trash our currency.
The U.S. private sector debt remains some $6 trillion beyond what is sustainable at our current GDP. As jobs and incomes are lost and tangible asset values decline, it is our citizens' debt that cannot be serviced. Treasury needs to focus on the orderly process of debt and credit elimination, and cutting govt expenses
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3-08-2009 @ 12:36PM
Jacob said...
Turiddu, capitalism is worse than TRUE communism. In our society, in order for one to accomplish and be successful, there has to be one who gets nothing and isn't successful. That is how capitalism works. Now I'm 24, but I've been preaching this to people since I was 18, in my last year of high school. I predicted everything, and I was told I was "crazy, insane, stupid, lost", ect.... Now people are coming to me asking and looking for answers as if I have them. I tell them the same thing as before. Lose the dollar. Trade it all in for gold. The only thing that can't be printed out of thin air. Plus all the companies in the US are liquidating cash assets and buying GOLD. There is obviously a reason for this. We are moving into a commodity based system, and unless you have gold, you will have nothing. The dollar will be like the mark during the 20's, worthless. Absolutely worthless. Low class, government dependent society is what they want.
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3-08-2009 @ 12:36PM
Jacob said...
Ha to all you people blaming Bush and Cheney. Oh spell his name right if you want to use it, CHEYNEY means nothing to me. His name has been around for over eight years and people still can't spell it right. But they sure do know a lot about this country and how it works! But, then again, if they did, they would be blaming the person before Bush. So I know how little, they know about history and the workings of our Government.
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3-10-2009 @ 12:36PM
Herman said...
If memory serves correctly this all began with junk bonds and other worthless instruments during the "deregulate" Reagan years?!? Remember the savings and loans that were allowed to florish only to flame out
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3-17-2009 @ 11:54AM
Dickie Joe said...
Mr. Gross is overlooking some basic tenets of human nature--there is no memory for pain (your last toothache) and the need to predict outcomes (gambling) is inherent.
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3-17-2009 @ 10:26PM
Chuck Vail said...
In his article Mr. Cohan says this: "But his (Gross') point about stocks as a subordinated income vehicle is interesting. If I understand him correctly, he views stocks as the bottom of the liquidation hierarchy -- meaning that if a firm files for bankruptcy, all the other stakeholders -- such as bondholders, lenders, and preferred stock holders -- get their money before the common shareholders see a dime."
That's an curious comment from the principal of a financial firm and a college teacher of management. I was ten when I learned that common shareholders are last in line when a company goes bankrupt. The way Mr. Cohan phrases the comment suggests that he thinks this hierarchy of liquidation is both startlingly perceptive on the part of Bill Gross (a patently ridiculous notion) and a new revelation to him, Cohan.
I intend no disrepect to Mr. Cohan, but the comment in question is just one of a number of strange things about his article, not least some of the syntax. He might want to consider running any future articles past a good editor, someone like, well...like me.
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3-26-2009 @ 3:26AM
Hon. Morris Toure said...
I am Hon.Morris Toure, Special Adviser(SA) to the Minister of Interior here in Nigeria. Presently i'm in United Kingdom (UK) for a vacation.
I am searching for good person who i will trust and be my foreign partner because i will like to invest in his/her country such like Real Estate and Hotel e.t.c. After the Investment, the ivestor will be entiled for 30% of all the total money invested.
Please contact me via email hon.morristoure@live.com
Best Regards.
Hon. Morris Toure
Reply
4-10-2009 @ 2:43PM
duke said...
The contents of # 152 are another scam!
My holdings have taken a bath. But with zero debt for decades and base holdings combined with SECURE pension we are in good financial shape. We planned to retire with zero due on house and beat it by fifteen years. The old payment (adjusted for inflation) was invested. And in retirement is still being deposited.
We always replace WORN OUT CARS when they are no longer safe to drive. We have cash in hand and never ever finance these purchases. Same for the replacement of major appliances. (which we recently did as the old ones were on last legs - or is it feet?) Paid cash for them too!
It takes a bit of sacrifice for a secure financial future. It can be done.
duke
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