In the aftermath of the 2008 financial crisis, bond guru Bill Gross spoke of a “New Normal” for US economic growth. Now he’s talking about the “New Neutral” for interest rates, and the impact it will have on investors.
Gross says neutral or natural interest rates are likely to remain lower than they were in the 80s and 90s. “The lower real rate/capital gains ocean liner has taken us into uncharted waters, but waters, which we must know, that are hostile to investors,” Gross wrote in his recent Janus Capital commentary. “Knowing how to maximize return versus risk in these new waters will be key. There are at least several approaches, any one of which may be the correct one.”
Gross says the “most attractive opportunity” appears to involve the European Central Bank quantitative easing plan, which “will keep yields low in Germany and therefore anchor U.S. Treasuries and UK Gilts in the process. I would not buy these clearly overvalued assets but sell ‘volatility’ around them, such that much higher returns can be captured if say the German 10 year Bund at 20 basis points doesn’t move to –.05 percent or up to .50 percent over three months’ time,” Gross says.
“Cheap leverage is an alpha generating strategy as long as short rates stay low and mimic the 0% real new neutral,” Gross added. “Of course if an investor borrows short term to invest longer and riskier, the potential alpha necessarily demands choosing the correct assets to lever. That is not easy these days since almost all assets are artificially priced. The challenge is to purchase the ones that might remain artificially priced over one’s investment horizon. For me, credit spreads are too tight and therefore expensive. Duration is more neutral but there is little to be gained from it in the U.S., Euroland, and the UK unless the global economy inches towards recession.”