Is Pimco’s Bill Gross right about the lack of a bond bubble?

23rd April 2013

img

The manager of the world’s largest bond fund – Bill Gross at Pimco – says that the bond bubble is going nowhere, at least for the next few years. His argument is that the global governments have yet to find a way to create organic economic growth and until that happens, supportive conditions for bonds remain. Investment journalist Cherry Reynard asks does this mean that investors do not have to worry about any imminent meltdown in fixed income and can cling onto their bond holdings? “I don’t see a bond bear market on the horizon until this magical potion of cheque writing and policy rate stabilisation creates some type of nominal growth.” His job, he suggests, is to work out which asset markets are ‘least bubbled’. This, he concludes, is the US treasury market, which are the ‘most stable of the over-valued asset classes’, as FT.com reports.

But is Gross’s gloomy prognosis on the global economy correct? Certainly the latest PMI data to emerge from the Eurozone suggests that – while there may be pockets of improvement – there is no overall recovery as the BBC reports. Germany has long been the backbone of the Eurozone economy and even it is increasingly seeing weakness. Markit data showed German PMI falling to 48.8 in April, below the significant 50 point mark that separates growth from contraction. The weak data prompted talk of a rate cut, but few believe that tweaking monetary policy at this stage is likely to stimulate economic growth.

China, another key source of global demand, has also reported weaker PMI data. The HSBC China Purchasing Managers’ Index, the first economic indicator for the second quarter, showed the expansion in factory activity eased in April. The UK seems unlikely to buck the trend. With all these key economies heading South, it seems Gross may be right and bond investors are safe for the time being.

He is not alone is suggesting that the developed world has gone ‘ex-growth’. Philip Poole, global head of macro and investment strategy at HSBC Asset Management says: “Just like a human life cycle, as economies mature they tend to grow less rapidly and at some point can stop growing altogether and even start to shrink, particularly if their populations age rapidly.” He points to academic research that suggests 2% per capita growth is about as good as it gets for wealthy countries.

However, the two ‘danger’ economies (for bond investors, at least), likely to surprise on the upside, are Japan and the US. The OECD revised its estimate of Japan’s GDP growth higher to 1.4% this year and next. This is below the 2% growth last year, but still an encouraging trend. In its estimates, the OECD is factoring in a decrease in sales tax from 8% to 5%, plus the impact of a weaker yen and higher share prices as MNInews reported.

That said, many believe that the Japanese government’s actions to weaken the yen will see money move out of the domestic fixed interest market and into global fixed income markets, though that hasn’t happened yet. Jim Leaviss, manager of the M&G Global Macro Bond fund says: “We expect some overseas buying, but at the moment we are seeing some front-running of that trend by investment banks to sell to Japanese investors.” As a result, any indication that stronger Japanese growth would lead to higher global growth, which would put pressure on the fixed income markets seems far-fetched.

The real swing factor is the US. Here growth is picking up: Official estimates are revealed later this week, but early assessments suggest that US GDP may have grown at an annualised growth rate of 3.1% in the first quarter of the year, up from 0.4% in the last quarter of 2012 reported on Bloomberg Economists point to strong gains in US consumer spending and an acceleration in the housing market as reasons why growth is likely to surge ahead.

It may be the strength of the US that will unseat Gross’s predictions. He has been wrong before. In 2011, he avoided US debt entirely, believing that quantitative easing would create significant inflation. The position let to a rare run of weak relative performance. He has changed his view because of the failure of quantitative easing to create any type of inflation. He also believes that bonds will continue to have a place for older people and there are an increasing number of old people to create demand.

Ultimately, Gross’s contention that Western governments have failed to create conspicuous growth is uncontroversial with the possible exception of the US. Equally, it is difficult to argue that there is still a lack of inflation in the system. However, it is more controversial to suggest that these are the only things that would unseat the bond market. The bond market looks vulnerable both from a valuation and a liquidity point of view and it would not take a significant shift in sentiment for yields to start to slide.

 

 

16 thoughts on “Is Pimco’s Bill Gross right about the lack of a bond bubble?”

  1. Anonymous says:

    Great column, Shaun. So far, at least the Bank of Japan doesn’t seem to be blowing up a house price bubble:

    http://tochi.mlit.go.jp/english/wp-content/uploads/2014/04/sokuhou_201401_en.pdf

    The Japan residential property price index (JPRI) for All Japan showed a 12-month rate of price change of -2.1% for January, down from December, when it was -0.9%. Unfortunately, a February update won’t be available until the end of this month. Andrew Baldwin

    1. Anonymous says:

      Hi Andrew

      Thanks for the numbers which reminded me to check out the house price numbers on the Economist web site these are not as up to date as your but do remind us that it has been a 23 year bear market now.

      http://www.economist.com/blogs/dailychart/2011/11/global-house-prices

      Also the situation regarding imputed rent is very different to the UK as without it private demand would be higher so it is falling!

      The numbers also remind me that Japan headlines the expenditure GDP number initially rather than output.

      1. Anonymous says:

        Thank you for this link, Shaun.The chart of house prices is very interesting. I am not surprised that British house prices have shown much higher growth than those of Japan over the last 30 years, but I was surprised that the same is true compared to the United States. On the other hand, they have only had one housing bubble in that period and you have had three.

  2. just a thought says:

    Hi Shaun,

    What are the prospects??? Who knows???

    I am always astonished by the amount of “pain” people can take or will endure before starting to do something for themselves, individually or collectively…

    1. Anonymous says:

      Hi just a thought

      JW pointed out a few days back that the Euro area showed a rising “pain” threshold if I can put it like that. The Japanese are very stoic so they would be likely to be able to take even more I think.

  3. Noo 2 Economics says:

    Hi Shaun,
    “Poor” is the euphemistic answer. It’s a pity Abe didn’t follow through on arrows 2 and 3 (fiscal and reform).

    He may have had a chance had he done as he promised especially on reform. One strange thing I noticed was that the Banks seem to be selling their holdings as fast as the BOJ is buying, so the money supply is doing what exactly?

    I never understood how a manufacturing country with little natural resources, having to import most of them, buying US dollars with a depreciating yen to pay for them could hope that this would boost exports?

    I posted here along time ago about the bizarre Japanese corporate culture of reducing wages of older workers which was always going to exacerbate the problem given Japan’s demographics. This is one of the reforms I was thinking of, but reversing this would need a culture change which usually takes at least a couple of generations and I believe the Japanese are very traditional. I read somewhere that Abe had a go by naming and shaming corporations that weren’t giving pay rises but it seems to have come to nothing.

    It’s fascinating to watch our future unfolding now on the other side of the world and provides an insight into just how long an inevitable disaster can be avoided – 22 years and counting……

    1. Anonymous says:

      Prior to Fukushima, Japan had a positive trade balance. The citizens savings were invested in govt debt. Hence foreign creditors could not cause problems.

      You comment about reducing wages of elder workers. I always thought Japanese wages rose on seniority – and more recently the younger workers were not getting similar pay rises like previous generations. If the latter is true, younger generations won’t have the money to bankroll on going govt borrowing.

      1. Noo 2 Economics says:

        Not sure what you’re getting at? I didn’t say Japan had a negative or positive balance of trade in previous years but am pointing out that as commodities (which Japan has precious little of) are paid for in US dollars when imported using a depreciating yen this has to add to input costs thereby increasing finished product costs unless savings are made elsewhere (wage levels?)

        1. Noo 2 Economics says:

          Sorry forgot – http://soberlook.com/2013_07_01_archive.html – “clock ticking on Abe to implement labor reform”

          1. Anonymous says:

            thanks for the link.

        2. Anonymous says:

          1 ) Am suggesting that Japanese savers have prevented financial meltdown to date.

          2 ) Am suggesting that demographics (Eg. time) is working against Japan’s finances.

          What happens when current savers retire and live off their savings ?

          1. Noo 2 Economics says:

            Agree all your points. It’s worrying Japan too, hence Abenomics to get the economy going so the shrinking younger generations will make more money to support the burgeoning elders.

            Kind of what’s beginning to happen here only on a smaller scale and we have immigration which (if it’s mainly younger workers) helps us.

            Unfortunately, Abenomics isn’t working – they MUST effect a culture change on falling pay to older workers, if the Barclays analysis via Sober Look is to be believed, that will at least immediately boost the economy through increased domestic demand (assuming the older workers actually spend their pay rises) and in the medium term hopefully allow Japan to start paying down it’s debt whilst in the longer term I still feel it will be a case of putting off the inevitable collapse.

            They need a greater birth rate too, then they might just scrape through. I marvel at how long they’ve kept the plates spinning though.

          2. Noo 2 Economics says:

            Theres one other thing, I believe the Japanese are not like westerners, they have a strong sense of loyalty to country.

            The current savers may decide to live very frugal retirement’s to help Japan and their children/grandchildren. I know this sounds foreign and unthinkable which underlines my point. The answer may lie in traditional Japanese values of sacrifice, stoicism and country.

            So just to contradict my earlier post it may be that Japanese culture doesn’t have to change at all to resolve their problems.

  4. David Lilley says:

    Shaun,

    So what is the best policy for Japan?

    May I humbly submit the following policy:

    1. Become a republic and install a second house.

    2. Mend relations with your neighbours. Make Wikipedia your history text book.

    3. Adopt the language of business, commerce, science
    and engineering; English.

    4. Get your nuclear reactors back on stream.

    5. Sell those islands to a third party with lots of covenants for $1.

    6. Cut off internet access to the Hikikomories.

    7. Allow women better access to the workplace.

    8. Promote dating agencies that match excess Japanese females to excess Chinese males.

    9. Don’t expect a government that gave your two lost decades to provide answers.

    10. Get an OBR and give it clout in deciding economic policy. Get off vulgar democracy and have some guardian rule.

    1. Anonymous says:

      11. Get a nuclear regulator with clout and outlaw “golden parachute” roles for regulator’s staff. Better still, recruit a foreign boss who doesn’t need to defer to elder utility CEOs.

  5. Anonymous says:

    Hi Forbin

    You are right to point out that the consequences of the Great Eastern Earthquake (tsunami and Fukushima) left Japan with an even larger energy importation problem. Although of course Abenomics made this issue worse by pushing the Yen lower.

    As to immigration the Japanese are a very homogenous nation and the least likely to even countenance immigration on any scale. If Abenomics pulls off that one then the third arrow of reforms will have actually achieved something.

    Actually own brand toffee popcorn has got dearer (was 85p per bag now £1.10) just as corn has got cheaper! More food for thought as to how pricing and inflation operate…

Leave a Reply

Your email address will not be published. Required fields are marked *