The Big Picture Isn't Pretty
The nation's leading fixed-income manager is bearish on the economy and bullish on municipal bonds.
By Manuel Schiffres, Executive Editor
From Kiplinger's Personal Finance magazine, April 2008
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When Bill Gross talks about the economy and the bond market, investors listen. Gross, arguably the nation's best-known bond-fund manager, is chief investment officer of Pimco, a Newport Beach, Cal., firm that manages fixed-income assets totaling $747 billion. He and his team are known for their uncannily accurate big-picture calls on the economy and the direction of interest rates.
Their forecasting skills have helped propel Pimco Total Return, the firm's flagship, to one of the best records in the fund business. The institutional share class (symbol PTTRX) returned 9.1% last year, compared with 4.7% for the average intermediate taxable-bond fund, according to Morningstar. Over the past 20 years to February 1, Total Return gained 8.4% annualized, compared with a category average of 7.0%.
You need $5 million to buy the institutional shares. Other classes with sales charges or higher fees are available with lower minimums. But Gross also runs Harbor Bond (HABDX), a low-minimum look-alike that is a member of the Kiplinger 25. Harbor's fees are only slightly higher than those of Pimco's institutional class.
With the economy weakening and markets in turmoil, it seemed like a perfect time to get Gross's perspective. What follows is an edited version of the interview, conducted on an unusually chilly day at Gross's Southern California office.
KIPLINGER'S: Is the U.S. economy in recession?
GROSS: I think so. The drop in consumption during the Christmas shopping season and the continuing housing debacle combined with a slowing global economy may have produced the beginning of a recession.
How severe a downturn do you expect? That's a hard question. Our economy has never experienced anything like this -- an implosion of the credit markets, a reversal of what we call the shadow banking system (meaning hedge funds, structured investment vehicles, all sorts of financial conduits), a reduction in lending of significant proportions and diminished prospects for a reversal anytime soon.
In previous cycles, the solution was always to lower interest rates, get banks in the spirit of things, and away we go. Now it's not so easy because the banks themselves have problems. And because adjustable-rate mortgages are passé, the housing market is not really linked to short-term interest rates anymore. The 30-year mortgage is the mortgage du jour, and 30-year rates aren't low enough to stimulate a housing recovery -- and probably can't go low enough. It's hard to know how long this will continue.
You've described a bleak scenario. It certainly paints a picture of very slow or even negative growth for much of 2008. And 2009 will not be that prosperous because the tools that we have used in the past to produce relatively strong recoveries are not applicable in this kind of environment.
Meaning one in which the banks are reluctant to lend? Yes. But in the past five years, lending has really been taken over by the shadow banks. To bring back the spirit of lending means that you not only have to get the banks healthy, but you also have to have some rejuvenation of this shadow system, which frankly is not coming back soon.
Did you manage to keep your funds out of the toxic areas? Two years ago, it became obvious with all the funny-money mortgages being created that something was amiss. And so what we did here at Pimco was to take ten of our credit analysts, the people who were following General Motors and IBM, and said, "Hey, that's not where the problem is. The problem is in real estate. So each of you is assigned to a different city in the U.S. Pretend you're a home buyer and come back and report on the trends in the housing market in your particular area." And so we were the first ones to know that subprimes were dangerous, and we stayed away from them entirely. That's one of the reasons we're at the top of the heap, as opposed to the bottom.
Is that how you managed to earn 9% last year at Pimco Total Return? We pulled off a double play. Staying away from the junk was the out at second base, so to speak. But to get the next out at first base, we acted on the expected policy response -- meaning the Federal Reserve lowering interest rates -- and we bought two-year and three-year Treasuries, safe assets but ones that would benefit from the decline in the federal funds rate that we expected. So the throw to second, the throw to first, double play.What's your assessment of the government's fiscal-stimulus package? I think it's required. It puts money back in the hands of Americans and consumers. But let's not forget that the problems that got us here are problems of consumption and undersaving -- that is, no savings -- and this just represents more of that. It takes money and puts it into the hands of a consumer in Des Moines, who spends it at a Wal-Mart, which ultimately shifts it over to China. That's fine. Let's give the economy a little bit of a jolt. But ultimately, fiscal policy has to be oriented into something that deals with infrastructure, R&D and housing, and encourages saving.
Where do you see long-term and short-term interest rates a year from now? I see the Fed ultimately going to 2.5% and the ten-year Treasury, which is now around 3.6%, probably remaining at around that level.
Reader Comments (1)
Posted by: Ron at 03/11/2008 05:25:33 PM
The economy is sliding into recession. The housing recession is negatively impacting property sales in Florida and across the south as well as slowing sales in NC mountain resorts that depend on Florida buyers. Still the downturn in prices and building of inventories is starting to attract second home buyers from Florida looking for cool temperatures in our mountains. Also the dramatic decline in the dollar combined with weakness in American real estate markets are beginning to interest some bargain hunting European investors....