…from the eye-catching-quote machine that is Mr Bill Gross.
The UK is a must to avoid. Its Gilts are resting on a bed of nitroglycerine.
In fact, the Pimco man is in fine form with his February letter to investors, in which he mulls his status as an aging (65) financial rock star, thanks people for the privilege of being a “steward of the capital markets” and then gets stuck in:
Having survived due to a steady two-trillion-dollar-plus dose of government “Red Bull,” Adderall, or simply strong black coffee, the global private sector is now expected by some to detox and resume a normal cyclical schedule where animal spirits and the willingness to take risk move front and centre. But there is a problem. While corporations may be heading in that direction due to steep yield curves and government check writing that have partially repaired their balance sheets, their consumer customers remain fully levered and undercapitalised with little hope of escaping rehab as long as unemployment and underemployment remain at 10-20% levels worldwide…
Like a regular investment sage, he’s scornful of the New Normal and any notion that This Time It’s Different, tipping his hat to the Reinhart/Rogoff tome of the same name and drawing three iron conclusions:
1. The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.
2. The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.
3. Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.
And then he presents us with this marvelous chart:
Leading Gross to observe:
Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada. Its conservative banks never did participate in the housing crisis and it moved toward and stayed closer to fiscal balance than any other country, 2) Germany is the safest, most liquid sovereign alternative, although its leadership and the EU’s potential stance toward bailouts of Greece and Ireland must be watched. Think AIG and GMAC and you have a similar comparative predicament, and 3) the UK is a must to avoid. Its Gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2 % and lower.
But what’s this? UK interest rates “artificially influenced by accounting standards”?
We must confess to being less than 100 per cent sure what Gross is eluding to here. It’s easy to lob Enron-esque insults at the way the UK’s balance sheet has been manipulated under the Labour government, but that’s surely not the Pimco point here.
Marc Ostwald of Monument Securities helps us out:
He could have been a lot more explicit in his rationale. I think what he is trying to say is that the whole QE process, i.e. the BoE indirectly buying £200 Bn of this fiscal year’s £228Bln of Gilt issuance is a rather dodgy bit of accounting (i.e. it is not far from the under-funding of the budget that occurred in the 1970s) , and on top of the regulatory (actuarial) pressure on pension funds to buy long-dated Index-linked Gilts has created very artificially priced Gilt and Index Gilt yield curves…
Gross tells us to “Beware the ring of fire!”
We’d extend the cautionary advice to investment managers selling their wares…