Wednesday, May 16, 2007

PIMCO-Gross "How We Learned to Stop Worrying (so much) and Love “Da Bomb”

good and long ( this is already a summary) piece from pimco. please keep in mind that when you read this "bullish" (except for us asssts....) piece from gross that he is a bond guy. we will see how the outlook will be when we will see "events" like (hedge funds, derivatives, failed lbo´s , popping bubbles in almost every credit market etc) .... we havn´t seen a real stresstest yet.....

guter und langer beitrag von gross. bedenkt bitte bei der lektüre das er die sicht eines anleihemanagers hat. zudem könnte einige der annahmen einem ernsten test unterzogen werden wenn wir wohl nicht zu verhindernde "ereignisse" im kreditmarkt (hedge fonds, derivate, unternehmenspleiten etc) gegenüber stehen. ..den wirklichen stresstest haben wir bisher noch nicht gesehen.....

...For the purpose of this Outlook, “da bomb” is globalization and all of its wondrous benefits – high growth, low inflation, accelerating profits, and benign interest rates. For that matter, you can compile a short list of critical factors that have aided and abetted globalization’s surge during the past decade or so: the information technology revolution, favorable government policies including inflation targeting and lower taxes, a shift to freer low cost markets in China and India, as well as moves towards deregulation and lower trade barriers worldwide. ......

These have been PIMCO secular themes for years now, but somehow after correctly analyzing the evolution of “da bomb” we never stopped worrying about it and how it might end; like Slim Pickens headed for his mushroom cloud destination 20,000 feet below, we were giddy, but subconsciously pretty darn worried. We foresaw rising global growth, but said it would be “moderate” due to a lack of aggregate demand. We spoke to a “stable disequilibrium” which referred to good times now, but maybe bad times on the horizon, and emphasized not the stability but the potential downside arising from trade deficit imbalances, U.S. debt buildup, and resultant financial flows. Those worries were enough to tilt portfolio constructions towards a more U.S. centric housing led slowdown which we hit right on the money, but they steered us away from a more global orientation where the rest of the world continued to experience 5%+ growth rates and to dominate financial market trends. ........

Secular Review
Globalization. Technology. Freer markets/financial innovation. Favorable public policy. These are “da bomb’s” critical components and we could spend paragraphs expounding on the influence of each. ....... accelerating global growth; disinflation; increasing returns on equity capital; and low real interest rates

......Interestingly, each of these trends has a common thread, as do the components of “da bomb”: The ascendance and dominance of capital vs. labor. Add a billion or so potential workers to the global labor force, blend in a technology S curve acceleration, combine these with deregulation, lower taxes, and free trade, and you have a recipe for accelerating returns to capital and diminishing returns to labor. Higher stock prices, lower inflation, declining interest rates and importantly a rather low volatility environment for both economic growth and asset prices have resulted. It’s known as the “great moderation” in economic circles, assisted not insignificantly by what has been called Bretton Woods II, a recirculation of surplus reserves into consuming nations that has promoted growth and lower interest rates – no mean feat in historical context.

What’s New?
Does this virtuous circle favoring capital at the expense of labor continue? We see nothing to stop it absent a global financial bubble popping of sorts, an accelerated decline of U.S. housing in the short run, or a U.S.-led trade policy reversal that could precipitate counter-attacks from Asian exporters. These three are not “black swans” as they say. Asset bubbles are a near inevitable result of attractively financed leverage in search of a limited array of financial assets – and the exuberance that inevitably accompanies them. In turn, if U.S. housing declines soon morph into the consumer sector, the belief in a U.S.-centric global economy will reemerge, and a cyclical argument for slower global growth will accompany it. Anti-trade legislation may or may not become a reality.....

A bigger threat to asset markets however, comes not from slower economic growth in the short-term, but inflationary pressures towards the end of our secular timeframe. Note first of all the increasing influence of non-core food and energy prices in G-7 nations over the past few years as illustrated in Chart 5 for the United States. Since 1967, average differences in headline vs. core inflation have essentially been zero, despite distinct periods of cyclical variation. Now, however, with globalization so dominant and Chinese/Asian appetites for oil, soybeans, and iron ore amongst other commodities so voracious, it’s hard to envision an extended period of lower headline U.S. increases.

thanks to

This may bias more central banks to begin considering headline numbers in their policy decisions like Japan and the ECB do already.

There are other global threats to the disinflationary character of “da bomb.” Chart 6 outlines an increasing trend of import prices from mainland China through Hong Kong and then outward. Admittedly, the appreciation of the Yuan has played a part, but that, I suppose, is the point. As the Yuan inexorably revalues, China’s ability to export deflationary impulses to the rest of the world becomes questionable, especially as it itself experiences internal inflation. China may still be exporting deflation to Asia and Euroland, but it clearly is beginning to export mild inflation to Japan and the U.S. ....

All of this will make interesting discussion points at Central Bank policy meetings for years to come. Over 20 CBs (Central Banks) are officially on the “inflation-targeting” bandwagon with the U.S. a de facto member since the appointment of Ben Bernanke. Yet even if the magic 2% inflation target is agreed on by nearly all G-7 policymakers, and a 3-4% target by many developing nations, once-reliable short-term rate targeting levers may not work as effectively. The abundant liquidity of today’s financial marketplace may be another way of describing the ability of private agents – be they hedge funds, private equity, or simply old-fashioned banks – to create credit on their own given satisfactory reserve levels which are now more than ample.
Unwillingness to employ increased margin requirements by the Fed during the NASDAQ bubble, and near 0% margin downpayments accepted by mortgage bankers during the housing bubble, give evidence to the diminishing influence of CBs and the growing influence of private agents in the credit creation process. ...

Financial Markets
These portents of higher inflation and still strong global growth may seem negative for global bond markets and indeed they are, but cyclical countertrends as evidenced currently in the U.S., Japan, and elsewhere suggest caution in overreaching just yet into bearish secular territory. ..... Following the flows (if you can) has been key in determining G-7 yield trends both short and long-term. Government intermediate and longer curves have been pushed down, and to counter the stimulative effect, short policy rates have been set higher than might otherwise be the case. To illustrate, “10-year real rates” throughout most G-7 curves have been lower in the past few years than they have been over the prior two decades as shown in Chart 7, part of a study done by PIMCO’s Ramin Toloui.

Now, however, a growing number of investors are trying to “be like Yale or Harvard” by moving toward more diversified asset allocations, and that includes the holders of over 50% of outstanding U.S. Treasuries, Chinese and Petrodollar central authorities among them. A day after our Forum’s conclusion, for example, China eased investment restrictions in order to allow its commercial banks to buy stocks abroad. Even without a buyers’ strike or a dramatic reversal of the U.S. current account deficit though, Treasury yields (and other widely held G-7 government issues) will lose some of their caché over the next few years and real yields may rise somewhat. .....

As an additional statement of fact, although without firm conclusion, it is striking that real global growth as shown in Chart 8 is advancing at a 5% potential rate while G-7 countries are mired at levels just above 2%. Low policy and term real rates reflective of this 2% growth are in effect financing global growth at 5% – an unprecedented spread for at least the last several decades. Investment managers and economists are fond of speaking of the Yen carry trade – borrow near 0%, invest much higher – as being the dominant liquidity lever in today’s marketplace. Chart 8 speaks to a broader more significant carry trade which admittedly cannot be efficiently employed due to capital controls and relatively immature capital markets (China, India, etc.). Still McCulley’s demand thesis can only stand in awe at the G-7 real yield/global growth rate gap, where G-7 yields in effect stabilize their own economies but serve to encourage attractive arbitrage opportunities into investments in the BRICs and other developing economies. One wonders if there may be some move towards closure in future years, a move that in turn would increase real yields, lower global growth or both.

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Blogger Lou Minatti said...

You are a bitter renter, JM. You have been priced out of the German real estate market. Everyone wants to move to Germany. The economy is booming. Sure, the bubble was elsewhere in Europe. But it never reached Germany. The Germans are much smarter than the English or the Spaniards or the Dutch.

9:52 PM  
Blogger jmf said...

hi lou,

i´m really happy that we are not in bubble territory.

but i doubt that everybody wants to move to germany. but at least lots of capital is moving to germany....and in german real estate....

it will be interesting to see how our economy will do when global grwoth will moderate. almost all dynamic is coming from the exports.

but compared to other countries with bubbles i think we are "outperforming" for years to come :-)

10:59 PM  
Anonymous Anonymous said...

Warum hat denn die 'Bubble' nicht Deutschland erreicht...?

9:37 AM  
Blogger jmf said...

wir hatten unseren "mini"bubble direkt nach der wiedervereinigung
ab 1990.

dort sind zig mrd € in den sand gesetzt worden und einige banken fast an die wand gefahren.

das hat uns "gerettet" :-)

10:23 AM  

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