You couldn’t find a more divergent view of the future of the US economy than those offered up today by Bill Gross of Pimco and Tim Bond from Barclays. Gross is not deviating from his persistent call of chronic low growth while Bond says we have it all wrong, a boom is coming.
Gross spends an interesting first couple of paragraphs in his monthly newsletter castigating other investment managers for the fees they charge. It’s not revolutionary stuff and it’s a bit self-serving, nevertheless he makes a good point about fees.
He then gets into the meat of his presentation which is an argument that we have for decades the country has operated on an assumption that nominal GDP would grow at around 5%. This is in fact what hat has happened and accordingly the structure is geared towards that sort of growth. Now we have slipped below that number and he sees constraints in getting back there.
Gross argues that the economy can not get back to the 5% level on its own due to overcapacity and is destined to wander in either a recessionary spiral or some sort of stagflationary environment. The remedy for this is for government to substitute for the private sector. Gross contends that government this time is limited in its responses. Government leverage, in his view, is less robust than private leverage and thus will not contribute as much to recovery. Additionally, he believes that both domestic and international political constraints exist that prevent government from doing much stimulus over and above what it has already committed to. The bottom line is his expectation for nominal GDP growth of around 3% once a recovery takes hold.
Here is his concluding paragraph:
Investment conclusions? A 3% nominal GDP “new normal” means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector, which substantially changes the character of the American capitalistic model. High risk bonds, commercial real estate, and even lower quality municipal bonds may suffer more than cyclical defaults if not government supported. Stock P/Es will rest at lower historical norms, and higher stock prices will ultimately depend on tangible earnings growth in the form of increased dividends, not green shoots hope. An investor should remember that a journey to 3% nominal GDP means default/haircuts for assets on the upper end of the risk spectrum, as well as extremely low yielding returns for government and government-guaranteed assets at the bottom end. There is no investment potion for this new environment other than steady income-producing bond and equity investments in companies with strong balance sheets and high dividend yields, as well as selectively chosen emerging market commitments where nominal GDP growth prospects are tilted upward as opposed to gravitating to new lower norms. Madame Rue has met her match.
And in the other corner sits Mr. Bond. He looks at the future through decidedly rose tinted glasses. Here is a summation of his arguments:
- The deeper the recession, historically the more vigorous the rally that follows. He sees no reason that shouldn’t be repeated.
- Asia is in the midst of a V-shaped recovery. It is real and despite the claims to the contrary they are finding a way to prosper without the American consumer. Basically, they can grow without the West but their recovery will pull the West along.
- Unemployment does not need to fall in order to experience a vigorous recovery. In 1982 unemployment topped out at 10.8% yet the economy grew by 7.7% over the next six quarters.
- Business panicked after the Lehman collapse and laid off too many workers and cut back output too drastically. Accordingly we could see a V-shaped recovery in employment.
- The negative effects of deleveraging are over stated. Business borrowing has historically declined in the early stages of every recovery since 1950. The easy availability of credit is not a prerequisite to a strong recovery.
- Consumers have made the appropriate adjustments to their savings rates and are not likely to cut consumption further. Additionally, low interest rates and low housing prices mitigate against further increases in the savings rate.
So over the rest of this year, the standard cyclical timing of a US economic turning point tells us pessimistic expectations are likely to collide with the economic reality of a strong recovery. The net result is almost inevitable, in the shape of an inexorable continuation of the equity rally.
There you have it. Take your pick. Me, I’m probably more in Bond’s corner. He makes some good points and I have a natural inclination to believe we are always too pessimistic at the bottom of a cycle. Besides that, I’ve watched this country bounce back too many times. I’m not willing to admit that we’re down for the count this time.