Bond guru, Bill Gross believes that investors need to be very careful in 2018, and has stated six areas that they should worry about in the New Year. He includes debt, liquidity and Bitcoin as areas of concern.
He is known for being cautious when it comes to investment, and below are just half a dozen reasons why he thinks that everyone should be.
The Federal Reserve have kept interest rates low whilst beginning the first steps of policy normalisation. This has provided a backstop for the economy and markets, but it also gives central banks much less room to move in the future.
The reason that he believes this is an issue is because investors have less insurance in the form of central bank manoeuvrability. He says on the matter;
“Should a crisis arise because of policy mistakes, geopolitical crises, or other currently unforeseen risks, the ability to protect principal will be impaired relative to history…That in turn argues for a more cautious and easier Fed than otherwise assumed.”
It is the surge in leverage since the financial crisis that has been a concern for Gross, amongst others. Gross cites economist Hyman Minksy, saying;
“[Minksy] alerted economists to the fact that an economy is a delicate balance between production and finance. Both must be balanced internally and then the interplay between them balanced well.”
Credit And Asset Prices:
Gross believes that capitalism depends on credit creation that leads to asset price growth, which will ultimately generate business investment.
He believes that this system can easily break down though;
“This model is leverage dependent and 1) debt levels, 2) the availability, and 3) cost of that leverage are critical variables upon which its success depends…When one or more of these factors deteriorates, the probability of the model’s success and stability go down.”
Cost Of Carry:
This refers to the price investors pay to hold assets on their balance sheets.
Gross believes that professional investors should be very mindful of the cost, and how it compares to whatever benchmark they are trying to beat. It is important that they move on when the carry equation no longer works;
“Timing that exit is obviously difficult and perilous, but is critical for surviving in a new epoch. We may be approaching such a turning point, so invest more cautiously.”
The Question Of ‘Money’:
Gross believes that when too many investors turned to cash and equivalents over credit, and this can create a liquidity breakdown in the system;
“When the possibility of default increases or the real return on credit or liquidity decreases and persuades creditors to hold classical ‘money’ (cash, gold, Bitcoin), then the financial system as we know it can be at risk as credit shrinks and ‘money’ increases, creating liquidity concerns.”
The Fed And Inflation:
The Treasury and the Fed have always had an interconnected relationship, but over the past decade, this has only increased as the central bank’s holdings of government debt has surged.
At this moment in time, the Fed is holding nearly $2.5 trillion of Treasury’s. The Fed is allowing a capped level of government debt to run off each month; but essentially what they have done is allow the government to borrow money, and pay a low level of interest on the debt.
“Money for nothing – The Treasury issuing debt for free. No need to pay down debt unless it creates inflation…For now, it is not. Probably later.”
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