Practicing yoga, while getting some of the best ideas standing on his head, Bill Gross has made bond investing sexy. The manager of more money than we can count of, has had some performance issues lately, and there is a growing concern of his abilities, and whether or not PIMCO is reaching that Too Big to Fail status. Insight from Reuters;
Over more than three decades, Bill Gross, co-founder of asset-management giant PIMCO, has made so much money for clients that he has become the barometer by which other bond traders are judged. His West Coast perch, prescient calls on the U.S. economy and devotion to yoga only added to the mystique.
But the very recipe that enabled Gross to dominate his industry may now be conspiring against him.
From the creator of the new normal, and the bimodal World, here are some points worth reading. By PIMCO’s El Erian via Foreign Policy.
The global economy is balanced precariously between total collapse and salvation. Here are four tipping points toward disaster and four things that could get it back on track.
The year 2012 is Europe’s moment of truth. If their dithering continues, European politicians will soon lose control of the continent’s economic and financial future. After all the excitement of 2011, it is also a make-or-break year for some Middle Eastern countries in the midst of tricky political transitions. Even the United States is being shaken out of its social slumber as concerns mount about income inequality and, more generally, the fairness of the “system.
(Full article here).
With equities grinding higher yet another day, and volume trend continues, markets seem sadly enough “disturbingly” broken. Good time to review what PIMCO thinks about the Economic outlook. From Pimco.
- We expect emerging Asia growth below the market consensus due to its less aggressive policy responses compared to 2008-2009.
- The Asia-Pacific region is less affected than others by eurozone turmoil but contagion is still a risk through direct trade and the regional production chains that characterize Asia’s export-oriented economies.
- In this environment, we favor Australian government bonds for their high credit quality, low-beta currencies such as the Chinese yuan, corporate issuers that have delevered, covered bonds and mortgage-backed securities.
While majority of European asset managers still enjoyed their Friday drinks, S&P were busy downgrading many of the European countries. Among the downgraded countries are France, Austria and Italy. Italy now has the same credit rating as Ireland, Kazakhstan, Colombia and some other “less” developed countries. Portugal on the other hand is ow at junk status. From S&P;
“Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone,”
S&P said the euro zone faced stresses, including tightening credit conditions, rising risk premiums for a growing number of sovereigns, simultaneous deleveraging by governments and households, and weakening economic growth prospects.
It also cited political obstacles to a solution to the crisis due to “an open and prolonged dispute among European policymakers over the proper approach to address challenges.”
Austerity and budget discipline alone were not sufficient to fight the debt crisis and risked becoming self-defeating, the ratings agency said.
Hardly surprising the German Finance Minister Wolfgang Schaeuble played down the news, saying: “In the past months, we’ve come to agree that the ratings agencies’ judgments should not be overvalued.” (Full article here).
From new normal to paranormal. What if the World is bimodal? Implications on risk, asset allocation.
It wasn’t long ago we were introduced to the “new normal”. This expression by El Erian is now widely used. The new normal, is going paranormal, as those tails are “fatter” than we believe, and guess wgat, it is not a perfect bell curve we follow.
The Trader covered the topic last year, “what if it is a bimodal world?”, but PIMCO’s Gross is out today again , telling us about the new normal. Just a reminder;
- The New Normal, previously believed to be bell-shaped and thin-tailed in its depiction of growth probability and financial market outcomes, appears to be morphing into a world of fat-tailed, almost bimodal outcomes.
- A new duality – credit and zero-bound interest rate risk – characterizes the financial markets of 2012, offering the fat left-tailed possibility of unforeseen policy delevering or the fat right-tailed possibility of central bank inflationary expansion.
- Until the outcome becomes clear, investors should consider ways to hedge their bets, including: maximizing durations, U.S. Treasury bonds that may potentially offer capital gains, long-term Treasury Inflation Protected Securities (TIPS), high quality corporates and senior bank debt, and select U.S. municipal bonds.
PIMCO’s not so rosy outlook of what to expect in 2012.
- As things stand today, it is more likely that the ECB will leap to a rescue only when it is too late. Absent any increase in private or external sources of aggregate demand, the eurozone economy will likely experience a recession in 2012.
- Chinese deleveraging and rebalancing could mean much slower Chinese growth and a smaller impact of Chinese aggregate demand on the global economy.
- We expect the global economy to grow by 1% to 1.5% in 2012. This is significantly slower than the 2.5% growth rate achieved in 2011 and the 4.1% rate achieved in 2010.
Since Econ 101 we have been taught to think in a “normal distribution” way. As many have seen, specially over the past years, the concept of normal distribution, fat tails etc, might look somewhat different than what we perceive it to be. With the extreme correlation in assets presently, the “equilibrium” of markets might actually look more like a bi/multiple modal. We would also like to add the new phenomena of HFT to the portfolio construction, but this topic has not been researched enough yet. PIMCO on the portfolio construction in a Bi Modal World;
- Fat tails and negative skewness in the distribution curve can arise from the mere possibility of multiple equilibria – even if both equilibria individually appear normal.
- Once markets arrive at a resting place among different equilibria, they tend to become trapped due to a variety of restraining forces.
- For all these reasons, we believe that the core building blocks of asset allocation and option pricing in the current macroeconomic environment should allow for the possibility of multimodality. This significantly changes the conceptual approach towards portfolio construction and risk management.
Full must read article for the “New Normal” World, click here.
Pacific Investment Management Co. Co-Chief Investment Officer Bill Gross and Chief Executive Officer Mohamed El-Erian, talk about the European sovereign-debt crisis and its impact on the U.S. economy and the role of Germany in resolving the turmoil. Despite having underperformed for a short time, when these gentlemen speak, one should listen. Video with the world’s biggest bond managers.