A rate call, not just actual rates, is what nailed the markets today. You can thank PIMCO’s Bill Gross for much of the sell-off today in equities and in longer-term bonds. If this continues, youcan look at our interest rate sensitive ETF picks.
He has issued a ‘change of heart’ at his recent annual Secular Forum to discuss global rate trends for the coming 3 to 5 years. He now believes that the old range for the 10-year US Treasury note is now 4.0% to 6.5%, up from last year’s target of 4.0% to 5.5%.
Now before you hurl yourself out the window over a higher rate and higher inflation environment, you need to consider that there are positives and this lends itself toward infrastructure, commodity, and many growth sectors. If you believe that Gross, now with Greenspan on his advisory team, is right this actually has many positive implications. What he is talking about is actually good for basic commodity companies, although it is not good for end-users buying finished goods and the companies who have signed hard contracts to produce goods at a price that they will have to purchase higher raw material prices for the commodities needed down the road.
Unfortunately, since Bill Gross is perhaps the most influential bond manager and since he regularly appears in the media many fear that a "Gross Prediction on Rates" can be a self-fulfilling prophecy.
HERE IS THE SUMMARY OF SOME OF THE COMMENTS (shortened):
Over the next three to five years, our secular outlook suggests that global inflation, and certainly U.S. inflation, will accelerate mildly for a number of reasons. We also suggest that global growth continues rather strongly at a 4% to 5% pace, which is typical of what we’re experiencing now.
That combination, I suppose, is not necessarily bond-friendly, especially in light of some of the changes that may take place in terms of financial flows—the recirculation of reserves from foreign central banks, et cetera. As a result, we’ve raised our forecast range for global interest rates, moving the range for 10-year U.S. Treasuries to 4.0-6.5% versus last year’s forecast range of 4.0-5.5%, for instance, which is sort of indicative of how we see the bond markets in general.
In addition, in terms of major conclusions, we think that asset managers and bond managers, to the extent that they can, should try to take advantage of global growth via minor positions in emerging market currencies. We expect the U.S. dollar to be weak going forward, for a number of reasons. And we think that commodity prices in general, based upon this strong global growth environment and the demand from the BRICs1 and the emerging market countries, will produce favorable results for commodities.
Those are our basic conclusions—not necessarily bond friendly but asset friendly in some ways, with the favored assets being emerging market currencies and commodities in terms of some of the more applicable asset categories. We also think that global stocks, especially those outside the United States, will benefit over this period of time.
MUCH CONTINUED AFTER HERE……..
In terms of the history, PIMCO has been sort of a glass-half-empty type of manager for the past few years……… But the glass-half-empty proposition took more account of that in terms of the debt positions of U.S. consumers, in terms of the U.S. trade deficit at 6% to 7% of GDP, and importantly, the lack of global aggregate demand, which still remains with us………… But nonetheless, we came to the conclusion this time that the glass is still half empty but it really is half full as well. And we also came to the conclusion that if we continue to see 4% to 5% global growth—admittedly with risks in a number of areas—perhaps this would exert some type of upward push in terms of inflation and ultimately in terms of interest rates…….. That is the evolvement and the change that has taken place this year in terms of our secular forecast, as opposed to last year.
if you wish to read the full link from PIMCO you can read it here.
I suppose 4% to 5% global growth is not a well-advertised number with the United States growing at somewhere less than 2% now and Euroland a little bit above 2% and Japan below that level as well. But when you factor in China and India and the emerging market countries, the historic growth rate in the past few years has been in this 4% to 5% category………..
In other words, if commodity prices accelerate at a near double-digit type of rate from this point forward over the next three to five years, then ultimately that’s going to have some type of effect on core inflation as well. Despite the fact that the U.S. tends to factor out commodity prices in terms of inflation calculations, ultimately that factors in………..
All of these factors suggest to us that global inflation might be moving slightly higher over the next three to five years. We suggest an average rate of inflation in the United States of 3%, an average rate in Euroland of 2% and an average rate in Japan of about 1%. That’s not dramatic but it is a mild change and a mild upward drift in terms of that inflationary outlook……..
Our outlook for mildly higher inflation, in and of itself, suggests that bond yields will probably be marching slightly higher………
…….And that to us suggests that purchases of safe, low-yielding assets—U.S. Treasuries, German bunds and other bonds—are likely to decline and flows into commodities and companies and equity-like types of investments will likely increase. We’re not talking about a major overnight shift but at the margin……
So the bond market has several strikes against it. As inflation moves higher and as the subsidy disappears, those two strikes count against the bond market and move U.S. Treasuries to a slightly higher yield range—4% to 6.5% for 10-year Treasuries as I mentioned earlier……….
I want to emphasize first that this is a three to five-year forecast. It’s not a three to five-month forecast and so the strategy implications of the Secular Forum really apply to the next several years rather than the next several months. Because of this, there is some contrast in the secular strategies versus our cyclical outlook for slower U.S. growth over the next several quarters and the Fed stopping its rate hike campaign at 5-1/4%.
In terms of secular strategy, this type of environment is not necessarily an attractive one for a typical bond manager. And PIMCO is primarily a bond manager, although we’re trying to offer attractive rates of return as well and are moving and have moved into commodities and stock-index types of products and other strategies………
First of all, in terms of durations and maturity positions, the secular environment implies that portfolio durations would probably be less than market indices as opposed to greater than market indices. That is one of the biggest shifts that I would anticipate for the next three to five years. And after 25 years of being a bull market manager to all of a sudden become a bear market manager—although mildly so in terms of higher interest rates over the next three to five years—is sort of a major shift. But I think it is a well-deserved shift, at least based upon the forecast that we’re suggesting…………
And finally, global growth at 5% does in fact promote a positive push towards global commodities, whether it be oil or soybeans or anything else. And so we believe an allocation to commodities is quite attractive in this type of environment…………..
We recognize that this secular outlook may sound like just the reverse of our shorter-term cyclical view. But I want to emphasize that over the next 6 to 12 months we continue to see a weak U.S. economy, based upon housing, and we do see the Fed reducing rates in the latter part of 2007, based upon that weakness in the economy. None of that has changed.
Therefore, over the shorter term—and that being the first year, I suppose, of the next three to five years in terms of the secular outlook—we see a mild bull market as opposed to a bear market. That is how the two pieces of our outlook, cyclical and secular, fit together. They don’t always correspond with each other in terms of bull-bull and bear-bear.
In this case we do like bond markets from this point forward for the next six months. But we do suggest in 2008, 2009 and 2010 that interest rates will be moving mildly higher and that less than index duration should be the consideration, as opposed to longer than index durations.