Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said unprecedented monetary accommodation has lifted prices of stocks and bonds to levels that exceed measures of true value.
“All asset prices, whether it be bonds, stocks, alternative assets are basically mispriced, artificially elevated,” Gross said during an interview on Bloomberg Television’s “Market Makers” with Erik Schatzker and Stephanie Ruhle.
“And I think the Fed knows that and wants to diminish that effect to the extent that they can. What they are going to do in terms of transition, we think, is simply to reduce quantitative easing to the point that by the end of 2014 they eliminate it, if they can if the economy responds.”
Fed officials this year have said there’s a risk of financial-market bubbles, as stock prices rose to record levels and bond yields remained near historic lows. Kansas City Fed President Esther George has highlighted an increase in farmland prices as a concern, and Richard Fisher, president of the Dallas Fed, has pointed to rising home prices in Dallas and Houston as a sign of a U.S. housing bubble. Fed Governors Jeremy Stein and Jerome Powell also have warned this year that some bond yields might be too low for the risk investors are taking.
U.S. shares are five years into a rally that has restored about $14 trillion to share prices. The Nasdaq Composite Index topped 4,000 for first time in 13 years on Nov. 26. Treasury 10-year note yields, which rose today to an 11-week high as reports showing the economy expanded added to speculation the Fed will slow bond purchases as soon as this month, touched as low as 1.61 percent this year on May 1. The average for the 10-year yield back through 1986 is 5.46 percent.
Labor Department data tomorrow will show the U.S. economy added 185,000 jobs last month and the unemployment rate fell to 7.2 percent, the lowest level since 2008, economists in Bloomberg surveys forecast. ADP Research Institute said yesterday U.S. companies hired 215,000 workers in November, more than the most optimistic forecast among economists surveyed.
The Fed will as they slow bond purchases “then use forward guidance in terms of maintain a policy rate of 25 basis points for a long, long time,” Gross said. Given risks of asset bubbles and to their balance sheet from all the bond buying, “the Fed basically wants out of there and they need to basically replace it with a forward guidance policy that allows investors to be confident that things aren’t going to be changed so much.”
Pimco is focused on shorter-maturity Treasurys, mortgage and corporate debt that will benefit by the Fed keeping its target rate for overnight loans near zero for several years, Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website on Dec. 3
Fed policymakers cut rates to a record low as the financial crisis mounted in 2008 and vowed to keep them there until the economy and employment show sustained signs of recovery.
“We’d stay at the front end because the front end rolls down at a very attractive rate,” Gross said in the TV interview. “That promotes some type of capital gain. You can combine that with some relatively safe credit and produce those 3 to 4 percent returns in the bond market.”
In equities, “stick to attractive p/e’s, high dividend yielding stocks that can maintain their dividend and whose companies are buying back their stock, that should give you a 5 to 6 percent return in a 2 to 3 percent growth world,” Gross said.
The performance of the $244 billion Total Return Fund over the past three years puts it ahead of 72 percent of similarly managed funds, gaining 4.2 percent over the period, according to data compiled by Bloomberg.
Pimco, a unit of the Munich-based insurer Allianz SE, managed over $2 trillion in assets.
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