Bill Gross, arguably the most powerful money manager in the world, has joined the ranks of Jeremy Grantham  in saying stocks have risen due to artificial influences and are now substantially overvalued.   In his latest monthly outlook Gross says “almost all assets appear to be overvalued on a long-term basis”.

He goes on to explain the long-term artificial price climb and the influence it has had on investors:

“The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services. American and other similarly addicted global citizens long ago learned to focus on markets as opposed to the economic foundation behind them. How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down. My point: Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.”

Gross says the result of these actions is that the current economic environment does not justify the high asset prices:

“What has happened is that our “paper asset” economy has driven not only stock prices, but all asset prices higher than the economic growth required to justify them.”

Gross even says policy makers know they must help to prop up prices and says we are tracking Japan’s path in an effort to keep the patient alive:

“This is where it gets tricky, however, because policymakers, (The Fed, the Treasury, the FDIC) recognize the predicament, maybe not with the same model or in the same magnitude, but they recognize that asset prices must be supported in order to generate positive future nominal GDP growth somewhere close to historical norms. The virus has infected far too many parts of the economy’s body, for far too long, to go cold turkey. The Japanese example over the past 15 years is an excellent historical reference point. Their quantitative easing and near-0% short-term interest rates eventually arrested equity and property market deflation but at much greater percentage losses, which produced an economy barely above the grass as opposed to buried six feet under. The current objective of global policymakers is to do likewise – keep the capitalistic patient alive through asset price support, but at an “old normal” pace if possible, six feet or 6% in U.S. nominal GDP terms above the grass.”

In conclusion Gross states that the rally in risk assets is likely at its pinnacle despite the Fed’s efforts:

“If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect. What you see in the bond market is often what you get. Broadening the concept to the U.S. bond market as a whole (mortgages + investment grade corporates), the total bond market yields only 3.5%. To get more than that, high yield, distressed mortgages, and stocks beckon the investor increasingly beguiled by hopes of a V-shaped recovery and “old normal” market standards. Not likely, and the risks outweigh the rewards at this point. Investors must recognize that if assets appreciate with nominal GDP, a 4–5% return is about all they can expect even with abnormally low policy rates. Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.”

His full commentary can be found here.


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. Nice sell call at the top TPC. Can you give your market outlook now that we’ve fallen some?

  2. Though I respect and agree with Bill Gross, he has said this for months. Just because this is true doesn’t mean we still don’t go above 1100. I mean, you see a 3% downward movement from the highs and everyone is geared up for this thing to fall again and say they were right all along. “Yup we knew there would be a correction. We said this is in April!”

  3. I was short term bearish in late September and October on Treasuries when I read about the huge influx of mutual fund money in Treasuries and the 66% of people who expected deflation on an 18 month horizon at Zero Hedge (let’s not forget earnings season). I lost my zeal for certain deflation trades, and trying to ride a trend (deflation) that most people do know about.

    Besides that, I am willing to defend long term Treasuries:

    One of the few asset classes that I do not see as “overvalued” are Treasury bonds. 10 year Treasuries at 350 basis points would be an excellent asset to own if one expects a world of low returns due to little innovation and mild deflation.

    If one is bearish on emerging markets, then buy Treasuries.

    And from Peter Thiel

    “Thiel is taking a long term time horizon and contrarian perspective as to whether this is a financial crisis at all. He asserted that productivity growth is the key to increasing the standard of living. Thiel explained that there are 3 ways to create productivity: Additional Leverage, Globilization and Science & Technology. We are witnessing the results of the Additional Leverage. Thiel believes the virtuous effects of Globalization are behind us. Instead of the disinflationary influence it has had over the past two to three decades, inflationary forces will take hold as nations compete for resources. In the area of Science and Technology, Thiel believes that things are not healthy in the ever expanding universe of human knowledge. Major research is turning out to be fraud and there is actually less progress than there appears to be in science. Technology, the application of science and also has not made much progress. Examples include the venture capital community, which has not made money in 10 years, there is no money being made in IPOs and the poor conditions of the State of California. Thiel believes this is not a new problem and this has been going on for a very long time. 1969 may be the year that progress died. Innovation has been barely enough to keep up with global constraints. Thiel referred to the Tech boom of the late 1990s as a fraud. He questioned how you get high returns in a world with such little innovation. You get the high returns through high leverage. High leverage is a symptom and cause of failed innovation of the past 40 years.

    Thiel believes there will be no V shaped recovery until the productivity issue fixed. He also noted that he believes the U.S. Government is nowhere near being on the right track. And he would fade the recovery trade, we will see inflation in assets we need (commodities) and deflation in assets we own. He believes the U.S. is radically misdiagnosing the problem. Washington is dominated by lawyers and economists and not the scientists that are necessary to correct the problem. Thiel referred to the situation as the myth of technological progress and asserted that most innovation we have received is hype. He discussed large cap tech names in a pejorative manor stating that betting on established Technology companies like Cisco, Microsoft and Intel is a bet on no innovation. He thinks we should be looking for companies that are truly innovating, of which there are only a handful.”

  4. He is a deflationist. He doesn’t have a bright economic outlook, but his deflationary outlook is perfectly in-line with his overall position on government bonds.

  5. Can I suggest maybe a portfolio tracking system of some sort? Your calls seem to be uncanny in their timing, but it’s hard to track if you don’t monitor the website and comments constantly.

  6. I am curious..With this call of Bill Gross, that wouldn’t give any lift to his trade would it??

  7. Buffett told us all to buy stocks in October and they fell 25%+ over the next five months. Allied Capital plummeted the day after Einhorn’s speech in 2002 only to rise above the pre-speech price – and stay there for almost six years. Talking your book does absolutely nothing in the long-term.

  8. Exactly, the question isn’t if someone is right, it is when the markets will recognize it!

  9. With Buffett though, you already know he talks about long term. I find it amusing when some pundits was pointing out that Buffett was so bad to get the option to buy GS shares @ $115…Where are those critics now? Still a bunch of NOT BILLIONAIRe losers. The main deal Buffett made with GS was the 10% interest on the loan. The OPTION to purchase shares @ $115 was just icing on the cake.

    I admit though, these so-called experts comment, you need to see their bets. Watch what they bet not what they say. Some was talking up gold while shorting it…

  10. Gross has a long time horizon. I think the main takeaway from his outlook is that you are unlikely to do well over the next few years if you’re buying into the market at these levels….

  11. The current bubble is occuring because one asset is more overvalued then the rest … cash.

    If all assets are overvalued, why would Cisco pay $3B cash or 10X P/S for a company?

    Also, re:Thiel’s comment on innovation. I think he also means productivity. India/Korea/China have done a lot with very little innovation. PC makers 30 years ago did great innovation which enabled certain kinds of productivity increases. Productivity can also be increased by decreasing salaries.

    Thus, the US is capable of greater productivity increases. I don’t think we’ve even begun to tap the power of electronics, wireless and networks. Unfortunately, the gap between upper and middle classes will increase, rejoining a trend that was interrupted in 1995-2007.

    Thiel’s implications are correct for the broad market, but not for the subsectors. If you look at the market cap of computer companies from 1965 to 1985, it was a nice rise, but not spectacular. The real investing greatness was to know when to switch from Control Data to Digital Equipment to MSFT. Don’t just buy the S&P.

    One thing that is true, related to the overvaluation of assets, is the investment competition. There are probably 1000 “solar” companies, backed by 500 VCs, 100 governments, 100 strategic investors, etc. This leads to overvaluation … why? … because cash is overvalued. Cash will become valuable again when there is a shortage … so, do you believe the government will create a shortage?

  12. Since when did Billy G become the expert dujour on Global macro investing? Is this the same Bill Gross who recommended going long GM bonds 18 months ago in Barrons? Granted he’s almost as good as Dan Fuss at Loomis Sayles,, but he never shares his real views, preferring to talk his book. as far as big picture calls, you’re as fool if you aren’t paying attention to Steve leuthold – a guy who just made a fortune for his clients being short.

    Remind me again, when did Grantham and Gross last make a timely short call? I thought so.

  13. Gross is a POS talking his book. He and Mohammed and Greenspan can all burn for all I care. He should be bk, we should HAVE WIPED HIM OUT ON HIS FNM/FRE DEBT.

    The fact that this guy manages so much money is reflective of how screwed up the system is.

  14. S&P 500 earnings and valuation.

    Overall earnings fell slightly short of expectations in Q2 (despite all the beating expectations). The bottom up analyst forecast on the first day of earnings season was $14.06. Actual earnings were $13.81. But GAAP earnings did blow away the top down estimates. They came in at $13.51 versus an estimate of $7.27.

    Once again in the third quarter the bottom up earnings estimates were dropped a bit. In July, the estimate as $15.05. The current estimate for Q3 is $14.78.

    I noticed in the S&P data that coming off both the 1990-91 recession and the 2002-2003 bottom that the market ended each quarter at a valuation of close the 19x the previous quarter’s earnings.

    The Q2 earnings were $13.81 or $55.24 annualized. 19x$54.24=1050. The S&P 500 stood at 1057 on 9/30. Coincidence or following historical precidence? If earnings come in at the currently expected $14.78 in Q3 then it would follow that the year-end target for the S&P 500 would be $14.78*4=59.12 x 19 = 1124. But one should probably expect overall earnings to come in a bit under estimates as usual (say -2% like in Q2) which would be about 58 annualized. Apply a 19 multiple and the year-end target is 1,100.

    Much simpler than the bull crap 74 forward earnings estimates trying to justify a lower multiple. No one knows the future so they project on the recent past.

    So that gets us to year-end at 1,100. Just over the GS 1060 target. The street finally has the free money to exactly hit their YE targets.

    What about next year? The current bottom up estimate for Q4 is $16.29 (top down in $12.31 so divergence between bottom up and top down is starting again). The expectation of a S&P 500 level in Q1 would be 19X $16.29×4 = 1,238. But the $16.29 estimate will surely come down before the end of Q4. Probably to about $15.90 so the S&P 500 target for the end of Q1 would be 1,208.

    Q4 earnings will massively beat prior year (which were negative for the first time), but ultimately they just might dissapoint and come in under estimates. If earnings are closer to top down estimates then 19x 12.31×4 = 935 which is close many estimates of fair value. Real disappointment at earings dropping versus the previous quarter (unthinkable!) might take the market back below fair value.

    If Bill Gross is right and interest rates will remain low, then all asset classes will probably remain overvalued for a while. If the bond market balks and demands higher yields, then assets will no longer be able to levitate.

  15. Rob – very good fair value analysis however, i’m not convinced the forward look P/E of S&P analysts’ models are geared appropriately for continued contraction in consumer credit (this is still the underlying problem and primary driver), in the giant eco-web organism of the consumer economy, credit is the energy for the market’s photosynthesis, w/out it growth becomes anemic. The credit contraction pressures continue.

  16. I don’t believe the foward P/E estimates. But I do believe that the market is projecting the most recent quarters results into the future in a similar manner as in the past (coming out of recession / bear market). Once things stabalize the PE drops quite bit.