Tipping Point

Bill Gross, who runs the world's biggest bond mutual fund at Pacific Investment Management Co., talks about the U.S. debt ceiling compromise passed by Congress and signed into law by President Obama, the outlook for U.S. tax policy and the state of the economy. Gross, speaking with Carol Massar on Bloomberg Television's "Street Smart," also discusses Federal Reserve policy and Pimco's investment strategy in the current climate.

Pimco's El Erian: Revive Growth

Government officials should examine why their response to the global financial crisis hasn’t revived growth when the International Monetary Fund and World Bank hold annual meetings in Washington next month, according to Pacific Investment Management Co.’s Mohamed A. El-Erian.

“The unifying theme should be the simple question: why is policy stubbornly ineffective,” El-Erian, the chief executive and co-chief investment officer at the world’s biggest manager of bond funds, said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “It doesn’t make sense for different countries to be doing things without coordinating. You don’t have enough coordination.”

Policy makers have been more successful when they have worked together in the midst of the global crisis, and risk allowing stagnation to persist should they fail to cooperate, El-Erian said. Newport Beach, California-based Pimco, which oversees more than $1.1 trillion of assets, says the world has entered a period of slower growth, more government intervention and less influence by the U.S. in what it calls the new normal.

“Policy ineffectiveness matters a great deal,” El-Erian wrote in an op-ed article published today by Bloomberg News. “The longer it persists, the greater the challenge of restoring industrial economies to the path of sustained high growth and job creation.”

Fragmented efforts are at risk from the outset as they are undertaken without regard for or examination of the efforts of their neighbors and trading partners, El-Erian said.

Several countries are at the same time trying to restrain government spending, push exports and lower the value of their currencies, El-Erian said in the radio interview. “Everybody’s self-interest is to do something that’s not in the common interest.”

“In the U.S. alone, just look at the high unemployment rate that persists in the face of unprecedented fiscal stimulus and the extended use of unconventional monetary policy,” El- Erian wrote. “In Europe, dramatic policy actions have failed to calm concerns about solvency risk in peripheral countries such as Greece, Ireland, Portugal and Spain.”

The biggest obstacle to achieving policy goals may be the amount of debt still on government and household balance sheets, El-Erian said in the interview. “Once you have overhangs, policy becomes less effective.”

Without coordination, policy makers have lacked imagination in their approach to the problems posed by the indifference shown to their initiatives by the lack of economic improvement, El-Erian said.

“We tend to do more of the same,” El-Erian said. “It’s called active inertia.”

When they have coordinated, policy makers have been effective, El-Erian said, citing the period from October 2008 to April 2009 as a “golden age” of cooperation that helped avert a meltdown of the global economy.

Efforts at addressing problems stemming from the global economic crisis without coordination may run a greater risk of failure, El-Erian said.

The Japanese yen tumbled from a 15-year high versus the U.S. dollar after Japan intervened to sell its currency and buy the greenback today for the first time since 2004 to curb gains that threaten an export-led recovery.

Japan’s currency slid the most in 22 months after Finance Minister Yoshihiko Noda said the nation unilaterally sold yen. The move comes a day after Japanese Prime Minister Naoto Kan won re-election as the head of the ruling party, beating a candidate who had insisted intervention was necessary.

“It is highly unlikely” to succeed, El-Erian said. “They’re getting the impact of the surprise. Now people are asking what’s next, particularly is it coordinated or is it one- off.”

(source: Bloomberg, September, 15, 2010)

Pimco’s El-Erian Says Greek Crisis Going Global

By Sree Vidya Bhaktavatsalam and Christopher Condon

May 7 (Bloomberg) -- Pacific Investment Management Co.’s Mohamed El-Erian and Loomis Sayles & Co.’s Dan Fuss said the European debt crisis may spread across the globe because of investor concern that governments have borrowed too much to revive their economies.

“After morphing into a regional dislocation, the Greek crisis is now going global,” El-Erian, the chief executive officer of Newport Beach, California-based Pimco, said yesterday in an e-mail. El-Erian shares the title of co-chief investment officer of Pimco with Bill Gross, who runs the world’s biggest bond fund.

U.S. stock markets fell again today after plunging by the most in a year yesterday on concerns that sovereign debt troubles in Europe will bring the global economic recovery to a halt. The Dow average dropped 1.2 percent at 11:39 a.m. It fell 3.2 percent yesterday after European Central Bank President Jean-Claude Trichet resisted pressure to take steps to fight the spreading crisis, and said the bank didn’t discuss buying government debt when policy makers met.

European stocks sank the most in 14 months as the Stoxx Europe 600 Index tumbled 3.9 percent to 237.19 at 4:47 p.m. in London. The gauge has retreated 8.7 percent this week, the biggest slump since November 2008.

Fuss, whose Loomis Sayles Bond Fund beat 96 percent of competitors in the past year, said the euro crisis had reached a “critical” point.

“It’s a liquidity issue, so it’s not just over there, it’s over here,” Fuss said in an interview.

The Standard & Poor’s 500 Index fell 1.4 percent to 1112.47. The euro gained 0.7 percent to $1.2702 after falling 1.5 percent yesterday.

“The transmission mechanisms for this latest round include disruptions in European inter-bank lines, a flight to quality, and market illiquidity,” El-Erian said.

Amid protests, Greece’s parliament yesterday approved austerity measures demanded by the European Union and International Monetary Fund as a condition of its 110 billion euro ($140 billion) bailout. German lawmakers today approved loans of as much as 22.4 billion euros to Greece.

The spreading contagion prompted an emergency conference call by Group of Seven finance chiefs. Kevin Rudd, Australia’s Prime Minister, said investors have judged Europe’s efforts to date as “inadequate.” U.K. Prime Minister Gordon Brown said the situation is “deteriorating.”

Europe’s debt-ridden nations have to raise almost 2 trillion euros within the next three years to refinance maturing bonds and fund deficits, according to Bank of America Merrill Lynch data.

“The issues in Greece are a global issue,” Axel Merk, president and chief investment officer of Merk Investments LLC in Palo Alto, California, said in an interview. “The recovery priced in that access to credit is available, and cheaply.”

Italy faces the biggest bill, followed by Spain. Greece needs 152.6 billion euros, while Portugal and Ireland each have to raise about 80 billion euros, the data show.

“There may well be some defaults. If not Greece then some other nation,” said Merk, who oversees $550 million. That’s “hitting the banking sector particularly hard.”

Europe’s fiscal crisis could threaten banks in Portugal, Spain, Italy, Ireland and the U.K. as the risk of contagion grows, Moody’s Investors Service said.

“If Merkel and Trichet don’t solve this, if they don’t work together, this could potentially mean the dissolution of the euro,” Ron Sloan, chief investment officer at Atlanta-based Invesco Ltd.’s U.S. core equity team, said in a telephone interview, referring to German Chancellor Angela Merkel.

Sloan added that there is a danger the debt crisis could spread to municipal debt issued by U.S. states that are struggling to balance their budgets.

“It’s the whole issue of risk appetite again,” he said. “If the euro sinks individual U.S. states will be the next step.”

The U.S. federal deficit is forecast to reach $1.6 trillion this year, or 10.6 percent of the economy, making it the biggest by that measure since World War II. Sloan manages the $5.5 billion Invesco Charter Fund, which has outperformed 97 percent of similarly managed funds over the past five years.

PIMCO’s Gross Says Rating Agencies No Longer Serving Valid Purpose for Investment Companies

PIMCO, which runs the world’s biggest bond fund, the PIMCO Total Return Fund, said on Wednesday that big credit rating agencies are no longer useful, since companies as big as PIMCO are quicker to anticipate shifts on credit quality of debt. Reuters has reported that PIMCO's managing director, Bill Gross, wrote in a May Investment outlook through company’s website, [ The credit rating agencies] ”no longer serve a valid purpose for investment companies free of regulatory mandates.”

Gross says that recent downgrade of Spain by Standards and Poor’s shows how timid and slow the three big credit rating agencies can be in downgrading sovereigns. On April 28, S&P cut Spain's rating one notch on the economic view. “S&P just this past week downgraded Spain one notch to AA from AA+, cautioning that they could face another downgrade if they weren't careful...And believe it or not, Moody's and Fitch still have them as AAAs,” Gross wrote.

Gross said that currently Spain’s unemployment rate is twenty percent and its current account deficit has touched the ten percent mark. As a result, government bonds in the market are trading in a way as if they were rated at Baa levels, which is in the lower echelons of investment grade. “Their warnings were more than tardy when it came to the Enrons and the Worldcoms of ten years past, and most recently their blind faith in sovereign solvency has led to egregious excess in Greece and their southern neighbors,” Gross wrote.

Pimco's Bill Gross Sees 2010 as Year of Reckoning

Not only does Pimco managing director Bill Gross oversee the world's biggest bond fund, his views often sway markets. In a late December interview with TIME's John Curran, Gross pointed to the second half of 2010 as a period when investors large and small will reckon with a new reality of poor economic growth and a Federal Reserve that is hard-pressed to offer much help.

Where do you see the economy going over the next six to 12 months?
The economy should be relatively strong in the first half of 2010, then weaken in the second half. That's not to say we'll return to recession, but we'll see weakness as opposed to a continuation of what will probably be a decent first half.

What will make the first half of 2010 so good?
The first half will be dominated by government stimulus and by inventory accumulation or a lack of [inventory] liquidation among businesses. I expect nothing from consumer [spending] and nothing really from housing or really any of the standard cyclical leading sectors. It's hard to put a number on GDP growth rates, but let's say 4% in the first half and then 2% in the second half, which would basically call for some additional help. (See TIME's 2009 Person of the Year: Federal Reserve Chairman Ben Bernanke.)

You're talking about a second shot of federal stimulus?
Yes. Something else is probably needed if the [government's] thrust is really reducing unemployment below double digits and renormalizing the economy. (See questions and answers about retirement.)

What does this say about the Federal Reserve's hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?
I think the Fed's statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying, and our sense is that they're at least going to try that. But based on our forecasts for the second half of the year, they may have to reinitiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they'll stop buying mortgage-agency securities, and the trillion-and-a-half-dollar check that's been written over the past nine to 12 months basically disappears. It's significant from the standpoint of interest rates and interest-rate spreads in certain sectors. And I would even go so far as to say it might be a mistake. (See the best business deals of 2009.)

Because they might have to restart the buying program later?
Yes. I think the Fed wonders about this as well. But you have to understand that the Fed's probably under political pressure — such as the hearings for new regulation of the Fed, the growing public unease about the supersized Fed balance sheet, etc. The Fed's expanded balance sheet is not something that I consider to be a problem, but I think the market does — and so the Fed will probably be working in the direction of pulling some of the liquidity out of the marketplace. They won't sell — it's a near impossibility to unload what they've purchased over past 12 months. But they'll at least stop buying. (See the worst business deals of 2009.)

Won't that put upward pressure on interest rates?
I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

But secondly, there's a ripple effect. Just speaking about Pimco's general portfolio strategy, we've sold our agency mortgage securities, Fannie and Freddie, in the billions to the willing check of the Fed. They're buying a trillion dollars of them, or have over the past nine to 12 months, and so we sold them a lot of ours. Now, what did we do with the money? We bought Treasuries, we bought corporate bonds, and so the bond markets in general have benefited, as have stocks, because this available money effectively flows through the capital markets. So it's a trillion-and-a-half-dollar check that won't be there as the Fed withdraws from the market. How that affects the markets, I just don't know. I'm not eagerly anticipating the answer, but I think it holds some surprises in 2010 — not just in mortgage securities but stocks as well. We could miss the money, put it that way.

(from Time, January 5, 2010)

Bill Gross: Fed Will Keep Rates Near Zero Through 2010

The Federal Reserve will keep interest rates near zero in 2010, but longer-term rates will gradually tick higher because of supply and demand, Bill Gross, founder of Pimco, told CNBC Monday.

"We have a lot of supply and perhaps not as much demand to satisfy that supply, and that may actually reinforce the move towards higher rates on the longer end of the yield curve," he said.

Gross said that stocks will perform "alright" in the long-term, but investors shouldn't expect the same double-digit returns as the Fed pulls excess liquidity out of the markets.

But Treasurys and other sovereign bonds, not stocks, are the most overvalued assets relative to the potential rate of inflation, he said.

(from CNBC, December 7, 2009)

What's Inside Pimco?

Pimco Total Return Fund is the world's biggest mutual fund. What's in its portfolio?

By Lewis Braham

Pimco Total Return Fund's (PTTRX) nearly $193 billion in total assets rival the gross domestic product of a small country—of Chile, Singapore, or the Philippines, say. It is the largest mutual fund ever, dwarfing its closest competitor, American Funds' Growth Fund of America (AGTHX), which has $145 billion.

Despite manager Bill Gross' high-profile media presence and sage counsel on macroeconomic trends, the inner workings of his biggest fund remain largely a mystery. He has made public statements about favoring plain-vanilla mortgage bonds and, more recently, Treasury bonds, but his portfolio is complex. At 368 pages, the bond fund's June 30 report of its holdings is so opaque that many investment advisers have trouble understanding it. Many don't even try. "I don't look too much at what's in there," says financial planner Ray LeVitre of Net Worth Advisory Group in Midvale, Utah, which has upwards of $5 million in the fund. "That's why we hire Bill Gross—to take care of what's in there."

But what is in there? Gross was not available to talk about the fund. A Morningstar.com snapshot of Total Return's portfolio doesn't help much. What Pimco considers cash, Morningstar counts as bonds, so the portfolio is leveraged from the fund tracker's perspective. As of June 30, it listed 131.3% of the fund's assets as bonds. An additional 58% was cash on the long, or positive, side of its balance sheet. And 94.6% was in cash on the negative or short side—a short sale being an investment that profits when prices fall. About 8% was in "Other," which at Morningstar can include convertible bonds, preferred shares, or derivatives. Such a portfolio, as described, would be akin to a leveraged hedge fund's.

"SYNTHETIC" BONDS

Pimco Total Return is no hedge fund, but it does use some hedge fund techniques. "Leverage light is a hallmark Pimco tool," says Eric Jacobson, Morningstar's director of fixed income research. But "the people at Pimco call it 'bonds plus.'" It generally involves derivatives: The fund buys futures contracts or other derivatives to get exposure to bonds instead of buying bonds directly. It puts down a fraction of the full value of the futures contract, or what is called "notional value," as collateral. A contract providing $100 million in exposure to, say, mortgage bonds, might require only $5 million in margin collateral, creating a leveraged bet.

To counteract that leverage, a manager could put the $95 million difference in Treasury bills. That would create what's called a "synthetic bond," since T-bills are considered risk-free and so neutralize the effects of leverage. But Gross often buys other bonds. More than 100 pages of the holdings report are devoted to "net cash equivalents," a vast array of debt ranging from mortgage bonds to emerging-market debt. The bonds are labeled cash because they have durations of less than one year. Duration is a wonky term that signifies how sensitive a bond's value is to moves in interest rates. If a bond fund's duration is 1.5 years, it means the fund will decrease about 1.5% in value if interest rates rise 1%, and it will increase 1.5% if rates fall by the same amount. For Pimco, anything with a duration of less than 1.0 and a high credit rating is a "cash equivalent."

According to Jacobson, Morningstar uses a different and more restrictive definition of cash than Pimco. To be labeled cash in Morningstar's terms, bonds must have maturities (not just durations) of less than one year. Many of the bonds in Gross's cash-equivalent section have maturities several years out. Thus, to Morningstar, the fund is leveraged in bonds—that earlier 131% figure—though Pimco would call that extra 31% cash. Either way, Jacobson feels Gross has managed risks effectively. "Pimco does well investing in these bonds with a little longer maturities than cash to pick up a few extra [decimal] points in return," he says. And the 94.6% negative, or "short," cash position in the Morningstar report is cash Pimco theoretically owes on its derivative contracts as collateral if you calculate their full notional value. It is not really a short position.

Although the Total Return Fund's leverage is mild and common among bond funds, there are risks. Manager Jeffrey Gundlach of the $11 billion TCW Total Return Fund (TGLMX) won't buy derivatives. "Many bond funds blew up last year that used derivative contracts, because instead of putting [collateral] money in T-bills, they invested in asset-backed securities they thought were the same as cash," he says. "Some of those securities fell more than 50%. Funds suffered massive losses because they were trying to goose returns by a few [decimal] points."

Gross, however, bested 95% of his peers over the past decade. (The percentage rises to 98% for the low-cost institutional share class.) The fund's derivative positions seem to have a big influence on performance. As of Sept. 30, a third of the fund's "duration exposure" was achieved through derivatives. Says Jacobson: "For the average manager, Pimco's level of derivative use would make me very concerned. What separates Pimco and Bill Gross is a demonstrated long-term track record of being really good at this type of investing."

Financial advisers tend to echo those sentiments. "I don't look at bond fund holdings but at how funds perform in different market conditions," says financial planner Jeff Feldman of Rochester Financial Services. "Derivatives are beyond my understanding, but if this fund were heavily leveraged, it would be more volatile than the average bond fund. But it isn't."

Of course, a basic axiom of investing is "know what you own." So what does it mean that the largest mutual fund in American history is tough to figure out? The fact is, no one seems to care as long as the performance is good.

With Tara Kalwarski

Braham is a freelance writer in Brooklyn, N.Y.

(from BusinessWeek.com, November 20, 2009)

Bill Gross on China bubble

China is running the risk of its own bubble by betting on renewed demand from US consumers that is unlikely to appear, the manager of the world's biggest bond fund said.

“The Chinese, I suspect, will have a bubble of their own to confront,” Bill Gross, who runs Pacific Management Co, or Pimco, told Bloomberg News. “It’s gearing up for export that doesn’t find an end consumer, that’s the real problem in China.”

China, now the world's third-largest economy, will expand 8.3pc this year, the Organisation for Economic Cooperation and Development forecast yesterday.

Many experts believe that China's policy of exporting its way to growth by holding down the value of its currency was central to the global imbalances that were at the heart of the financial crisis.

(from Telegraph, November 20, 2009)

DDRs – delevering, deglobalization, and reregulation

... Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

This focus on the DDRs – delevering, deglobalization, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult. They are as follows:

1. American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.
   
2. Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”
   
3. Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.
   
4. United States housing and employment. Old normal housing models in the U.S. encouraged home ownership, eventually peaking at 69% of households as shown in Chart 1. Subsidized and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.
   
   Similarly, the financialization of assets via the shadow banking system led to an American era of consumerism because debt was available, interest rates were low, and the livin’ became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save – the second mortgage would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.

I could go on, reintroducing the negatives of an aging boomer society not just in the U.S., but worldwide. Increased health care may be GDP positive, but it’s only a plus from a “broken window” point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new “green” society. Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.

The investment implications of this New Normal evolution cannot easily be modeled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, “new.” The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes. As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:

1. Global policy rates will remain low for extended periods of time.
2. The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
3. Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
4. Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
5. The dollar is vulnerable on a long-term basis.

Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes.

(from September Investment Outlook by PIMCO's Bill Gross)