Bill Gross’ latest investment outlook is up at PIMCO and he echoes the theme everyone is now talking about – irrational exuberance. He goes into great depth, saying that we are at about 6 on a scale of one to ten when measuring asset price irrationality. But he advises staying the course and expecting lower returns.
Just yesterday, Ben Bernanke gave a full-throated defense of the Fed’s easy money policy but gave voice to the concerns that Fed Governor Jeremy Stein voiced about “reaching for yield”, a term I have used often.
Bernanke referenced the risks but waved them off almost immediately.
Another potential cost that the Committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. On the other hand, some risk-taking–such as when an entrepreneur takes out a loan to start a new business or an existing firm expands capacity–is a necessary element of a healthy economic recovery.
This is not what Janet Yellen did in 2010 when making the same kind of defense of the Fed’s easy money. She ended her speech saying
Will future regulators and monetary policymakers be accused of bursting 10 of the past 2 asset bubbles?
These dangers are real. But the events we’ve recently lived through make it clear that we have no choice but to embark on this road. We’ve all been asked, “Didn’t you see this mortgage disaster coming? Why didn’t you do anything about it?” Our task now is to implement intelligent policies to contain future bubbles and credit binges, and to make sure that those that do occur inflict a lot less damage on the economy. Next time I hope we can say, “We did see it coming, and we did something about it.”
It might be lip service since Yellen is a dove, but it’s a good deal more hawkish than Bernanke’s testimony. And remember, this is two years after Yellen’s speech, meaning two years further into the Fed’s easy money policy.
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For an investor – especially a fund manager – missing the upside can be a career-ending proposition. Ergo Gross recommends staying fully invested and trying as best as possible to ride through the rough spots, cognizant that the overall returns will be lower as a result. I would also add that entry points are critical then. There is no point in getting in late and chasing return by going overweight momentum sectors or asset classes. Rather, we should expect better performance by overweighting when sectors and asset classes have underperformed and have good prospects.
Is this the hallmark of a secular bull market? I don’t think so.