Gross on Haircuts, Shared Burdens, and those Green Shoots

In his latest Investment Outlook column on bond giant PIMCO’s web site, Bill Gross says that the recent crisis — and the government’s response to it — has changed the financial landscape, and that investors must be cognizant of the new economic and investing world that has been created.

President Obama’s comments on the recent bankruptcy announcement of Chrysler, Gross says, have highlighted Obama’s populist streak. And, while he doesn’t seem to be criticizing that stance or Obama’s other economic positions, Gross says they will create consequences that investors need to be aware of. “The rebalancing of wealth from the rich to the ‘not so rich’ is a long overdue reversal, one that I have encouraged … for at least the past several years,” Gross writes. “But promoting and siding with the majority of the American public in their quest for change does not mean that as investors, we at PIMCO stand star-struck like a deer in front of the onrushing headlights, doing nothing to protect clients. Our task is to identify secular transitions and to preserve and protect capital if indeed it is threatened. Now appears to be one of those moments.”

“How does one invest during such a transition?” Gross asks. “Investors should recognize that this grassroots trend signals – most importantly – an increasing uncertainty of cash flows from financial assets. Not only will redistribution and reregulation lead to slower economic growth, but the financial flows from it will be haircutted and ‘burden shared’ by stakeholders. In turn, the present value of those flows should reflect an increasing risk premium and a diminishing multiple of annual receipts. … As wealth is redistributed, and the invisible private hand of Adam Smith begins to resemble more and more the public fist of government, then asset values should be negatively affected. First comes the haircutting and burden sharing, most recently evidenced by Chrysler and soon to be played out via the stress testing and equity dilution of government ownership of ailing banks. In those footsteps, however, will follow a slower rate of economic growth, not just in the U.S., but worldwide as heretofore libertarian capitalism is bridled, saddled and taught to trot instead of gallop over the investment plains.”

Gross says he’s not complaining. “Slower growth can be a public good if it avoids the cataclysmic effects of double-digit unemployment, escalating foreclosures, and fear of financial insecurity,” he says. “But the Obama cannon shot will have financial consequences.” He warns investors not to be deceived by the talk of “green shoots” and proclamations of bull markets. “Stable and secure income is still the order of the day,” he writes. “Risk will not likely be rewarded until the global economy stabilizes and the Obama rules of order are more clearly defined.”

Gross also says investors shouldn’t expect that things will “revert to a mean or median standard representative of outdated political and economic philosophies. Mohamed El-Erian’s and PIMCO’s ‘new normal’ should trump green shoot exuberance for years to come.”

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