Monday, April 25, 2011

Bill Gross Proves That Big Does Not Make Right

Back in February 2009, $1.3 trillion (2011 assets under management) PIMCO head, Bill Gross saw me on TV suggesting that he had too much sway over U.S. financial policy. He did not like my comments, emailed me with his thoughts, and gave me an interview in which he proclaimed that stocks were dead. Since then, the S&P 500 has skyrocketed. Now Gross is saying that thanks to the U.S. budget problems, its government bonds are not a good place to invest. Is Gross wrong again?

Gross is an American who bets against our stock and bond markets. He sponsors CNBC's Bond Report, whose Rick Santelli kicked off the Tea Party. Back on February 26, 2009, a week after Santelli's rant, Gross told me that he thought stocks would be a terrible investment because the U.S. economy would not grow and that since stocks were at the bottom of the liquidation hierarchy -- with bank debt at the top -- there was no point in taking the risk of buying stocks. Since then the S&P 500 has risen 82% from 735 to 1,337.

Now, Bloomberg reports, Gross is betting against U.S. Treasury securities. He is promoting the view that the U.S. economy is in a shambles and therefore PIMCO will no longer finance its deficits by buying its debt. With S&P's announcement that it had a negative outlook on the U.S.'s AAA-rating, Gross got support from a contributor to the financial crisis.

But, as I posted, bond yields reflected market optimism after that announcement. The four largest U.S. bond traders disagree with Gross, according to Bloomberg, and the continued decline in the 10-year Treasury yield suggests that the market has voted against Gross. That's because a lower yield means that investors are buying Treasuries and are willing to get a lower return to own them. Since Feb. 8, 2011, the yield on 10-year Treasuries has fallen from 3.77% to 3.39% on April 22, reports Bloomberg. This lower yield means that bullish bond buyers are overwhelming Gross's pessimism.

If Gross is not buying, someone else is. And those someone elses are foreign governments and banks. The U.S. Treasury reports that foreign holdings of Treasuries rose $36.4 billion to $4.47 trillion in the first two months of 2011. And banks increased their Treasury holdings by $49.1 billion to $1.67 trillion since the end of 2010.

For both groups of buyers, U.S. Treasuries appear to be the safest place to park their spare cash -- especially for banks that after getting bailed out are too risk-averse to boost loan volume. Bank loans at $1.25 trillion in April 2011 remain well below their  $1.62 trillion October 2008 peak.

Gross's economic pessimism persists in the face of stellar corporate earnings supported by high productivity gains. According to Bloomberg, since April 11, 71% of 188 MCSI World Index companies reporting have exceeded analysts' estimates for their first quarter 2011 EPS by an average of 8.8%. It looks like a productivity trend that started in 2010 is continuing to boost these results. For example, U.S. employee output per hour, increased 3.9% in 2010, the most since 2002 and unit labor costs fell 1.5% in 2010 after falling 1.6% in 2009.

In short, companies are squeezing more work out of their employees while cutting their pay. Maybe Gross's economic pessimism flows from his sympathy with the plight of the American working class. But with the S&P 500 up 82% since Gross's bearish call on stocks and companies beating earnings expectations, it sure is not based on hard-nosed financial analysis.

The lesson: Ignore Gross and buy stocks.


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