In his August Investment Outlook on PIMCO’s web site, bond guru Bill Gross talks about two key — and interrelated — issues: whether the government will be able to “reflate” the economy to match past longer-term GDP growth figures, and why avoiding the big fees most investment advisors and funds charge is so crucial today
Gross says nominal GDP growth has to grow close to 5% — its long-term average — for the economy’s long-term balance to remain intact. “Now, however, things have changed,” he says, “and it is apparent that there is massive overcapacity in the U.S. and indeed the global economy,” which has driven GDP down. “If allowed to continue -– and this is my critical point –- a portion of the U.S. production capacity and labor market will have to be permanently laid off. … Employment levels become unsustainable, retail shopping centers unserviceable, automobile production facilities unprofitable, and the economy itself heads towards a new normal where unemployment averages 8 instead of 5%, housing starts total 1.5 instead of 2 million, and domestic auto sales 12, instead of 16 million annual units.”
“Can [policy makers] successfully reflate to 5% nominal GDP and recreate an ‘old’ normal economy?” Gross asks. “Not likely. The substitution of government-backed vs. private-leverage is one strong argument against the possibility.”
“The ‘new normal’ nominal GDP, the future return on our stock of labor and capital investment, will likely be centered closer to 3%, for at least a few years once a recovery is in place beginning in this year’s second half,” Gross predicts. That, he says, means a number of things: lower profit growth, permanently higher unemployment, capped consumer spending growth rates, increasing involvement of the government sector, and stock P/Es resetting at lower historical norms. “Higher stock prices will ultimately depend on tangible earnings growth in the form of increased dividends, not green shoots hope,” Gross says. “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.”
All of this means investors also need to be more cognizant than ever about fees, Gross says. “While some index and ETF proponents avoid this extreme absurdity with lower fees, roughly 90% of the $1.5 trillion in 401(k) and other defined contribution assets in mutual funds are in actively managed offerings with expenses close to 1%,” he says. “Paying for those potions during an era of asset appreciation with double-digit returns may have been tolerable, but if investment returns gravitate close to 6% as envisaged in PIMCO’s ‘new normal,’ then 15% of your income will be extracted” in the form of fees.
