Bill Gross: the four 'hidden haircuts' facing investors

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From a trim to a full-blown shaved head, PIMCO’s Bill Gross is warning investors that investors are heading unwittingly towards a series of hidden haircuts on their investments.

In his latest Investment Outlook, the bond market veteran said even if QE and nominal low interest rates boost growth – a view Gross is very critical of – then investors will suffer in different ways.

Gross, who runs the $289 billion PIMCO Total Return Bond fund, said he expects investors to face a series of ‘surreptitious’ trims to their current holdings through a variety of channels.

‘These haircuts are hidden forms of taxes that reduce an investor’s purchasing power as manipulated interest rates lag inflation,’ said Gross.

Breaking it down into four distinct types of haircut, Gross said there are a variety of reasons as to why current holdings will no longer represent an authentic store of value.

Hidden haircuts

1. Negative Real Interest Rates – “Trimming the Bangs”

Pointing to the widespread WWII tactic of artificially capping interest rates below the rate of inflation, Gross said the US was able to lower its Depression-era debt/GDP from 250% to almost half in a number of years.

However, he warned, while some central banks are attempting similar measures now, this causes distortions to the average cost of money.

‘The government’s gain, however, is the saver’s loss. Investors are being haircutted by at least 200 basis points judged by historical standards, which in the past offered no QE and priced Fed Funds close to the level of inflation,’ Gross said.

2. Inflation/Currency Devaluation – “the “Don Draper”

Comparing the inflationary scenario to the lead character in 60s ad-based series Mad Men, Gross said inflation is the long-held, everyday issue that many investors don’t normally pay much attention to. However, this can change sharply.

‘Sometimes, though, it gets out of control, and when it is unexpected, a decent size hit to your bond and stock portfolio is a possibility. If our TV idol Don Draper lives another decade or so on the airwaves, he’ll find out in the inflationary 70s.’

‘As central banks surreptitiously inflate, they also devalue their currency and purchasing power relative to other “hard money” countries. Either way – historical bouts of inflation or currency devaluation suggest that your investment portfolio may not be “good as the money” you might be banking on.’

3. Capital Controls – the “Uncle Sam Cut”

Drawing parallels with the iconic image of Americanism, Gross said the he used the Uncle Sam example as a means of how the US can latch onto your money and capital, as happened under FDR in the 1930s.

During this period, the private holding of gold was illegalized in order to control capital, which Gross said is apparent today in currency pegging in China, import taxes in Brazil and more outright examples such as those seen in Cyprus.

‘Governments use these methods to keep money out or to keep money in, the net result of which is a haircut on your capital or your potential return on capital. Future haircuts might even include a wealth tax. Are gold and/or AA+ sovereign bonds good as money? Usually, but capital controls can clip you if you’re not careful.’

4. Outright Default – the “Dobbins”

Finally, and perhaps most severely, Gross pointed to the ‘ultimate haircut’, which is named the Dobbins in honour of a 1920s 5-year bond which was payable in either dollars of machine guns.

‘By purchasing Treasuries and Agency mortgages they have rather successfully incented the private sector to do their bidding.’

‘This behavior reflects the admission that modern-day developed economies are asset-priced supported. Unless prices can continuously be floated upward, defaults and debt deflation may emerge.'

‘Don’t buy a Dobbins bond or a Dobbins-like asset or a bond from a country whose central bank is buying stocks. They probably aren’t “good as money!”’

Investment strategy

While Gross said this situation would lead many investors to consider ditching the market – or ‘taking their ball and going home’ as he puts it – but the PIMCO fund manager advised against this.

Instead, he said: ‘PIMCO’s advice is to continue to participate in an obviously central-bank-generated bubble but to gradually reduce risk positions in 2013 and perhaps beyond.’

‘While this Outlook has indeed claimed that Treasuries are money good but not “good money,” they are better than the alternative (cash) as long as central banks and dollar reserve countries (China, Japan) continue to participate.’

To read the latest Investment Outlook in full, please click here.