Bill Gross, Co-CEO, PIMCO, has published his latest (February) investment outlook, titled BEEP BEEP!
Here are some highlights:
PIMCO's thesis for several years has held that the levered global economy long ago morphed from a banking-dominated regime to one that hid behind securitized lending and structures resembling a shadow banking system. SIVs, hedge funds, CDOs and increasingly levered mortgage and investment banks fueled asset appreciation in all investment markets, which in turn propelled real economic growth and employment to unsustainable levels. But, with U.S. housing prices as its trigger, the delevering process did a Wile E. Coyote and headed over the cliff in mid-year 2007, dragging down almost all asset prices except government bonds. The real economy followed shortly thereafter, not just in the U.S., but globally, proving that linkages work on the down as well as the upside. To PIMCO, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices. If that can be done, the real economy will level out as well. When home prices stop going down, newly created households will be more willing to take a chance on ownership as opposed to renting. If stock prices consolidate, recently burned investors will be more willing to invest, as opposed to stuffing their 401(k) mattresses with Treasury bills. Business investment, jobs, and profits should follow quickly behind.
The simplicity of the solution, however, is not easily achieved once deflationary momentum takes hold. Animal spirits, once dampened, are hard to reignite; fear of fear itself dominates greed. Under such circumstances, the benevolent hand of government is required and Keynes is reincarnated in an attempt to plug the dike via fiscal spending and imaginative monetary policies that support asset prices. PIMCO has recently been contracted to assist in several publically announced programs which have helped in that effort: the CPFF, which has benefitted commercial paper yields, and the Federal Reserve's purchase program for agency-backed mortgage loans, which has lowered 30-year mortgage rates to 4.5% and fostered the affordability of new and secondary housing prices. These two programs, in our opinion, have been the major policy successes to date â€“ not because of our involvement â€“ but because they have supported and increased asset prices whose decline has been the major deflationary thrust behind the real economy. Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama's targeted three million new jobs will have a fighting chance of being achieved.
Rather, asset prices securitizing commercial real estate and credit card receivables, as well as plain old-fashioned municipal bonds, must stop going down if the real economy has any chance to revive by 2010.
Example: CMBS or commercial real estate mortgage-backed securities are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable. How best to bring those yields down is debatable: another CPFF-like structure with self-insurance and contributed fees as its equity backstop? A generous portion of remaining TARP billions providing a reserve cushion for Federal Reserve funding? A good bank, bad (aggregator) bank structure? All three are being debated by policymakers and we should have clarity within a week's time. But one thing is certain: an economic recovery is dependent upon commercial real estate prices stabilizing and most retail stores staying open for business in the months and years ahead.
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