Who: Bill Gross
Title: Chief Investment Officer and Founder
Company: Pimco
Quote
"Mr. Greenspan might be remembering how George's father blamed the Fed for his defeat for the second term that he was seeking, so Mr. Greenspan is going to be leery of repeating that same mistake again."
Market Target for 2004
Interest rates will remain at their historic lows for much of 2004 with the potential to rise slightly in the second half of the year.
Stock Picking
Buy Treasury Inflation-Protected Securities (TIPS). They offer attractive yields and hedge against the threat of inflation over the long run.
Avoid the stock market. It's too richly valued. Gross expects the Dow eventually to trade at 5000.
Favorite economic indicator: Raw-steel production. Gross follows raw-steel production's trend of capacity utilization. At 82.3%, he says it's up 10 percentage points from a few months ago. This, he argues, shows that the economy is strengthening.
2004 Outlook
The outlook for the bond market isn't particularly strong. With interest rates at historic lows, the only thing most fixed-income securities can offer investors is a way to hold on to the wealth they've already got, says Pimco's Bill Gross. That may not be such a bad alternative if you agree with the beloved bond guru that the stock market is, well, grossly overvalued.
"Dow 5000 may be years away, but current valuations in the U.S. still argue for caution despite the ability of most companies to compensate for inflation via price increases over the long term," Gross wrote in his December research report.
The good news is that Gross is somewhat optimistic about the cyclical outlook for the economy. He's forecasting an economic upturn in the U.S. over the next six to 12 months, which should have a positive spillover effect on global demand. That's certainly welcome news.
Now for the bad news. This may not be enough to fix what's ailing the economy as a whole. Gross worries that this revival will either exacerbate or fail to redress secular imbalances such as the U.S. current-account deficit, structural rigidities in Europe and huge public-sector debt in Japan. He doubts the recovery will be sustained beyond a cyclical time frame because confronting these so-called imbalances will ultimately constrain domestic growth.
Then there's Gross's concern over the falling dollar. The greenback has shed some 20% of its value — and many on Wall Street are expecting it to drop another 10% during 2004. That's not a positive catalyst for the bond market. "You see, a weaker dollar ultimately means higher inflation, and that is the enemy of every bond investor," Gross says. As inflation moves higher, he explains, perhaps by half a percentage point, interest rates will move up accordingly.
So how should bond investors weather 2004? Gross suggests they start off with some Treasury Inflation-Protected Securities, or TIPS — the ultimate safe investment. Not only do they offer income, but they also hedge against inflation by insuring a real rate of return.
Gross is also eyeing municipals and emerging-market bonds. Munis's tax-free yields come pretty close to Treasurys, and they're less vulnerable to selling from non-U.S. investors. (Many people fear that foreign countries, such as Japan, will dump their Treasurys if the dollar continues to fall.) And high-quality emerging-market bonds should perform well since they'll benefit from the pickup in growth in developed economies in the near term, he says.
In such an unsure environment, it's only natural that some people will consider avoiding the bond and stock markets entirely and put their money into real estate. As Gross points out, a home can indeed be a very attractive investment in a reflationary period. Since most of us can't pay cash for our humble abodes, he offers us some advice on mortgages. We warn you, it may sound a bit contrarian.
Despite mortgage rates sitting near historic lows, Gross recommends homeowners and those looking to refinance avoid the 30-year fixed-rate loan. Instead, he prefers a 15-year fixed-rate mortgage, which should be priced 50 basis points or more lower than its 30-year alternative. He's also a fan of even shorter length mortgages, as well as adjustable-rate mortgages, since they'll carry a lower interest rate than the fixed-rate variety. "The way for homeowners to borrow close to 1%," he argues, "is to finance their home via an adjustable-rate mortgage geared to the short rate," he writes in a December research note. "If you can live with the volatility, you'll have more in the bank over the long-term."
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