Monday, June 30, 2008

Bill Gross and Mohamed El-Erian : The PIMCO maestros.

Bill Gross is again out with a no holds barred punch at the administration and the current state of affairs. He predicts a trillion dollar deficit for the next administration, and a severe inflationary uptrend.

I had linked to his earlier excellent missive and CNBC appearance here. There’s also a discussion where I speculated that a mean reversion in the price-earnings multiple to ~12 could be the fat tail PIMCO is watching out for.

It’s good to see wide media coverage for both Bill Gross and Mohamed El-Erian. I'm generally a fan of fixed-income strategists. While Gross has a nice straightforward way of assessing things, El-Erian's measured tone makes him really interesting to watch or read.

I’m currently reading El-Erian’s "When Markets Collide", and it’s been a gripping read so far. His analysis on the current situation is really thought provoking. I think this is shaping up to be one of the must read books of the year, especially to understand the current situation and the shape of things to come. (Think Taleb’s Black Swan in 2007). You can read the reviews from this Amazon link to pique your interest:

You can also read the introduction to the book from PIMCO’s website.

An excerpt from the introduction follows:

A series of inconsistencies and anomalies, which will be detailed throughout the book, acted as early signals of the growing tension between what participants or actors on the global finance stage were pressing for and what could be reasonably and safely accommodated by the existing systems in order to minimize the risk of turmoil.

Market participants first become aware of transformations through what is commonly known as “noise.” This noise comes initially from the sudden emergence of anomalies to long-standing relationships that participants take for granted. Noise can matter in so far as it contains signals of fundamental changes that, as yet, are not captured by conventional monitoring tools.

For what seemed an eternity for investors (many of whom feel that a week is a long time), the U.S. bond market provided signals about the economy that conflicted with those coming out of the other most liquid market in the world, the U.S. equity market.

This inconsistency was accompanied by a rather peculiar situation among Fed watchers, that group of economists and analysts on Wall Street who make their living from predicting the course of the most influential interest rate in the world—the fed funds rate. In the middle of 2006, with the rate at 51⁄4 percent, the vast majority of Fed watchers fell into two distinct and opposite camps. One confidently predicted rate hikes—to 6 percent; the other equally confidently predicted cuts—to 4 percent. I remember noting several times that I could not recall such divergence in sign and size among such credible market observers.

Hmm.. Don’t we have a similar situation right now? Market strategists and economists seem divided between whether interest rates are headed up (read PIMCO's missive) or down(eg. Gary Shilling). There's even a divergence between countries cutting or raising interest rates. Is this signal telling us something? The current divergence could be hinting at the shape of things to come over the next year or so. It's all about observing signals in the noise.

My 2 cents is that yields would probably come down in the next year in a deflation scare, before treasuries enter a decade long bear market. Even Hussman extended bond duration a few weeks back. PIMCO’s investment thesis, while right in the long run, could underperform this year.

Full Disclosure: None