William H. "Bill" Gross is one of the two Pacific Investment Management Co. LLC founders who is still with the giant fixed-income firm, which now manages more than $400 billion worldwide, mostly for institutional clients. Mr. Gross joined Pacific Mutual Life Insurance Co. in 1971 as an analyst. Soon after, he and James Muzzy — the other remaining founder and managing director — set up an investment management subsidiary to seek pension fund clients. Over the years, Mr. Gross has acquired a reputation as the dean of fixed-income money managers through astute investment decision-making that has kept PIMCO portfolios near the top of the performance rankings. Mike Clowes, editorial director, interviewed him on the economic and investment outlook for next year and beyond.
Driven to Win: Face to Face with Bill Gross
A Yes, I do. We have fought the battle of inflation vs. deflation here for a number of years, as has the financial world. The Fed fought it last year, briefly, and that's what sent the 10-year Treasury down to 3.1%. This might be the most important theme — inflation vs. deflation. The deflation forces are pretty strong. The five-letter phenomenon called China is a huge deflationary force, as are the demographics of the G7-G10 world, most of which is growing older by the day. ...
The counterpoint is obviously government trying to reflate. The U.S. has done its best with negative short-term real interest rates, with increasing budget deficits and with the wished-for depreciation of the dollar, all three of which are reflationary. The rest of the world, in smaller steps, in somewhat different style, is trying to do the same. …
I don't know who's going to win for sure, but in the past the printing press has won. The U.S. faces enormous liabilities … and the typical government response is not to meet its liabilities but to inflate them away. As long as we are the reserve currency, and we have the printing press, I suspect that's the winner.
A Yes, certainly in the U.S. because of our depreciated currency. Our estimation shows that a 10% trade-weighted devaluation of the dollar — and we've seen about 15%-plus over the past 12 to 18 months — adds about half a percent to inflation over the next several years.
A As a matter of fact, they've come down from the earlier highs during the year, much to the surprise of everybody. … That's been a big surprise and due substantially to two things. One, the continuing negative short rates offer what the trade speaks of as "carry" — the ability to capture that spread (between short rates and long rates), even though the spread in recent months has diminished. The other is what I call "the kindness of strangers," China and Japan and others who seem to have a priority that speaks to keeping their people employed as opposed to losing money in sinking Treasury prices or a sinking dollar. It's this kindness of strangers that has supported 10-year Treasury yields at 4.25% for most of the year and now at 4.35%.
A I suspect … there are some geopolitical reasons for their hesitation. They want Taiwan back, and if they can own so many Treasuries and therefore have so much power over our future and our fortune in terms of holding on to them and not selling them, then they can extract geopolitical concessions. The first step would probably be moving to a basket and we may be seeing that now — not only a basket of currencies, but a more diversified basket of bond holdings, which implies a marginal shift to euroland and the bund market. Therein lies opportunity to make lots of money if we are correct. In fact, that's where PIMCO has made most of its money this year. We've twice been on the right side of the U.S. to German bund trade.
A I think it's substantial. It depends on the kindness of strangers and whether they want to continue to accommodate our excesses. We consume to excess, and to a certain extent that has been the salvation of the rest of the world. But there is a point where other nations will no longer be willing to subsidize that, and we appear to be at the beginning of that point. …
A We are making progress. A good 3% or 4% growth rate helps. I suspect, however, given the proclivities of government, and despite this 1% limitation on future spending in the next fiscal year, that we are looking at deficits as far as the eye can see. This recovery of 4%, plus or minus — some quarters more, some less — has been manufactured on the basis of one, cheap money, and two, a surplus moving to deficit. Congress can't go too far in cutting back — you can't emulate the Clinton period or else you shut the economy down.
A Our orientation is still toward (Treasury inflation-protected securities) and German bunds. The inflation break-evens have gone up substantially on TIPS, and the yield spreads between bunds and Treasuries have gone from flat to negative. But I would still prefer to put my money, even at low yields, in a country where inflation is a prime concern and they don't have a balance sheet or a currency as vulnerable as ours. TIPS are a good bet still because of the potential for inflation, the budget deficit, negative real interest rates, a depreciating currency.
I certainly wouldn't take any kind of credit risk because of the potential for what we call an "unwind," but also because there is just no payoff. Spreads on junk, spreads on investment-grade corporates, spreads on emerging, for that matter, are near historic lows, and I know a better way to make 75 points over Treasuries than those areas — for example, riding the yield curve in terms of a two-year or five-year note and doing it every three months in terms of rolling back up the curve.
We take the same attitude going forward into 2005, that at some point there will be an unwind, the unwind being a desertion of previously successful trades, either high yield, corporate bond-related, levered corporate bond-related … this wonderful world of spread where nothing can go wrong. We think that things can go wrong.
A It's a little complicated by the dollar. … One, a weaker dollar does improve our ability to compete. Second, a weaker dollar does help multinational companies in terms of their offshore profits. ... I suspect that absent an unwind or Armageddon situation, stocks will do better than bonds in this type of environment because a declining currency is definitely a negative for bonds and may not be as negative for stocks. Ultimately, as the boomers start to retire, there is going to be some decent selling pressure on stocks.
A As long as my faculties permit. I love to do what I do every day. ... Sometimes I come in early, like today 5 a.m., 5:30 a.m., but generally about 6:30 a.m. I can leave about 4 p.m. and go and hit golf balls. ... I'm driven, not by money, but by a need to compete, to win, to demonstrate some type of expertise.