I have become particularly fascinated with PIMCO's Bill Gross lately. No, I'm not going to go all "Single White Female" and start wearing my hair in a weird comb-over. I just believe that he is one of the most influential, intelligent investors out there right now.
Many people don't realize just how much influence Mr. Gross has. I encourage everyone to read the outstanding article about PIMCO and Gross that appears in this month's Fortune magazine to see what I am talking about:
Pimco's power play
Bill Gross is deftly navigating the most treacherous market in modern times. But is the bond king too big? Does he have Washington - and us - over a barrel?
I just came across an interesting follow-up article on a new (at least I think that it's new, I've never seen it before) AOL site called Daily Finance this afternoon, Bill Gross, the $747 billion bond man, declares the death....... The first line of the article is certainly attention-grabbing, "Stocks are dead for the rest of your life."
I am definitely taking Gross' thoughts on this subject with a grain of salt. He is notorious for talking his book as they say in the industry and as possibly the world's most powerful bond investor he certainly will benefit if stocks take a back seat to bonds. Having said that, his opinions on the subject are definitely worth reading. Here are a few quotes:
In Gross's view, the current economic contraction is killing the animal spirits that drive risk taking and that's contributing to the death of equity capitalism as we've come to know it..."things will never be the same. Risk taking has been destroyed and any animal spirits must come from Washington.
Global growth rates -- low, low, low -- asset classes will be readjusted for that outlook. That is -- stocks will be more of a subordinated income vehicle as opposed to a 'stocks for the long run' growth vehicle."
And in Gross's view, growth prospects are so dim that there is no point in owning stocks since common stock investors will not benefit when there's no economic growth. Moreover, they'll be last in line for any dividends that might be available.
Meanwhile, Gross has an interesting analysis of how we got into this mess. He attributes it to too much borrowing, weak regulation and greed. He also thinks that the U.S. is going to have to come up with as much as $5 trillion to fill the capital hole in the banking system.
As Gross said,
"The cause of the current situation was too much leverage leading to over consumption which was facilitated by lax regulation and good ol' fashioned greed. Human nature will never change but our institutions will.
Not sure policymakers understand what needs to be done -- there is still a $4 trillion to $5 trillion capital hole that needs to be filled but politics may inhibit necessary action. Bernanke and Co. get it though and have more freedom and flexibility -- they are independent -- for now."
Gross certainly is right in one respect, common stock is at the bottom of the totem poll in the capital structure of companies. In the event of bankruptcy, holders of common stock almost always get completely wiped out. Bondholders and even the owners of preferred shares get paid out first when a company's assets are liquidated.
Furthermore, dividend-paying companies that run into financial difficulty stop paying divies on common stock before they stop paying them on preferred stock and bonds (yes I realise that payments on bonds are technically interest, not dividends, but you get the point).
The increased safety of bonds and the security of their payouts is the reason that I have completely limited my investments to them and preferred stock, mostly the former, over the past several months.
As some background about my interest in the area, I personally was heavily involved in investing in bonds years ago, until all of the leverage, arbitrage, and hedge funds in the system made risk premiums on bonds almost nonexistent. I finally decided to move away from bonds at that time.
The debt for some really scary companies, like the domestic automakers, was trading at such a small premium to much safer things that I just could not get the yields that I felt were necessary.
Flash forward to today. The leverage is being slowly wrung out of the system and people are scared. While fear is a bad thing for consumer confidence and equities, it is a great thing for bonds. Even with the Federal Funds rate as low as it is (between 0-0.25%), I am seeing bonds out there right now with amazing yields.
I have been able to pick up bonds in companies that were considered bulletproof, like Alcoa, Dow Chemical, Corning, Goldman Sachs, and JP Morgan Chase to name a few that sport yields of near, or even greater than 10%+. The Hidden Gems like Montpillier Re which has reasonably short term debt out there now has a 13% yield to maturity.
Bonds don't have to be completely boring either. To keep myself entertained, I've even taken a few small, short-term fliers on some really messed up stuff like Textron and BofA. I could go on and on about the interesting issues that are available out there.
If you think that the economy is a mess and will likely get worse for the next year, like I do, there's no logical reason to step in front of that freight train and purchase common stock. Even if you say that you are buying for the long-run, why do so now when things will likely be cheaper several months down the road?
The state of the economy is a crucial element to how companies perform. Continued economic weakness will be an absolute nightmare for the common stock of many companies.
I'm not saying to abstain from investing during times of weakness, just to be more careful. At this point, I'm not looking to hit any home runs. I have been spreading out my bets and buying things that are fairly high up the capital ladder, like preferred stock and bonds with yields from 9% to 11%. Most of the bonds have reasonable maturity dates, just in case interest rates explode in the future...which is a distinct possibility.
I will gladly take a solid 10% return and sleep well at night rather than hoping that the economy turns around soon when most of the important evidence that I have seen says it won't. Consumers are in too much debt and housing is still too expensive. The economy will not get better until those simple issues are repaired.
Anyone who earned a 10% annual return over the past two decades would be pretty darn happy right now. I certainly am not completely opposed to buying common stock. I eventually will begin to do so again when I see some signs that the economy is stabilising.
If I miss out on a piece of the upside, sobeit. I now usually buy common stock looking for solid dividends rather than capital gains anyhow, but that's a story for another time.