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Bill Gross: Buy More Bonds, High Quality Stocks, and Emerging Markets

August 27, 2009

guruek

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(GuruFocus, August 27, 2009)Bill Gross, Managing Director of PIMCO has published his August 2009 Investor Outlook in a piece entitled: "Investment Potions". As usual, I found his article hard to decipher and here is my best effort to summarize:

1. Gross ridiculed investment managers as "portion sellers" for instead for love but for "hope". Equity mutual fund managers charges an average of 1%. PIMCO envision the future investment return will gravitate toward 6%. The performance of the active portfolio managers hardly justifies the hefty fee they charge.



2. Financial companies may have stablized but the real economy is not. High unemployment has resulted from numerous business models that are now broken: autos, home construction, commercial real estate development, finance, and retail sales.

3. In the indefinite future, reflating nominal GDP by inflating asset prices is the fundamental, yet infrequently acknowledged, goal of policymakers. If they can do that, then employment and economic stability may ultimately follow.

4. In the past few decades, the real economy has grown at the rate of about 5% per year. For technical reasons that I do not want to get into, and that I do not Bill Gross adequtely presented, normial GDP will be reset to about 3% for the next at least a couple of years.

5. What does it mean to investors? I am glad you asked, here is the most important part of the article:
Investment conclusions? A 3% nominal GDP “new normal” means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector, which substantially changes the character of the American capitalistic model. High risk bonds, commercial real estate, and even lower quality municipal bonds may suffer more than cyclical defaults if not government supported. Stock P/Es will rest at lower historical norms, and higher stock prices will ultimately depend on tangible earnings growth in the form of increased dividends, not green shoots hope. An investor should remember that a journey to 3% nominal GDP means default/haircuts for assets on the upper end of the risk spectrum, as well as extremely low yielding returns for government and government-guaranteed assets at the bottom end. There is no investment potion for this new environment other than steady income-producing bond and equity investments in companies with strong balance sheets and high dividend yields, as well as selectively chosen emerging market commitments where nominal GDP growth prospects are tilted upward as opposed to gravitating to new lower norms. (The emphasis was added by me)


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