Some Tough Love Financial Advice

Bill Gross has settled in at his new outpost at Janus Capital and is out with his first Investment Outlook commentary.

He writes in part:

I have the following tough love advice – somewhat resembling the counsel given to me in recen tweeks: there is a new financial era. Accept it and modify your behavior accordingly, so that your future is safe, secure, and you look forward to a brighter tomorrow. I will explain.

Financial markets are artificially priced. In the bond market, there is nothing normal about a three year German Bund yielding a “minus” 10 basis points. Similarly, UK Gilts and U.S. Treasurys have in recent years never experienced such low yields and therefore high prices. The same comparison can be applied to stocks. While profits in many cases are at record highs, the discounting of future profit streams by an artificially low interest rate results in corresponding high P/E ratios. Real estate cap rates, which help to price homes and commercial shopping centers, are affected in the same way. 

While monetary policy with its Quantitative Easing and forward guidance for low future interest rates have salvaged a semblance of growth and job gains – especially in the U.S. – they have brought prosperity forward in the financial markets. If yields can’t go much lower, then bond market capital gains are limited. The same logic applies in other asset categories. We have had our Biblical seven years of fat. We must look forward, almost by mathematical necessity, to seven figurative years of leaner: Bonds – 3% to 4% at best, stocks – 5% to 6% on the outside. That may not be enough for your retirement or your kid’s college education. It certainly isn’t for many private and public pension funds that still have a fairy tale belief in an average 7% to 8% return for the next 10 to 20 years!

Earlier in the overview, Gross noted:

 The dancing has begun to resemble the last stages of a 1920s marathon with partners clinging to each other in a desperate attempt to keep from falling down.

Gross has a point here, We are in very unusual times. I don't expect it to remain quiet. Indeed, in the EPJ Daily Alert, that went out earlier today, I speculated that the very recent extreme volatility in the stock market may be the first step in increased volatility across the board that we will also see in bond markets, commodity markets and foreign exchange markets. We are in a very unusual period with the potential for massive crosstrends that cause extreme volatility.

There is a lot of late stage dancing ahead, but it won't be the like the Charleston dancing, popular in the late 1920s. It will be more like an out of control RAVE, hidden in darkness with drugged out attendees.  It won't be a place for conservative money. Hell, it won't even be a place for insane money. When the market is in rave mode, it is a time to stop dancing and head in another direction.