In his January commentary, uber-bond manager Bill Gross shows a favorite chart he uses as a bond market timing tool:
This series of graphs is used by PIMCO to indicate when enough is enough – "the point at which adjustable short rates rise sufficiently to make the economy, cry "no más!" That point comes in this example when Fed Funds rise to meet the average cost of intermediate Treasury financing issued over the past 5 years and the spread between the two disappears."
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click for larger graph
Source: PIMCO
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Note the distinction between this chart and the yield curve:
"For sophisticates, please note that this is not the same thing as a flat yield curve. A flat yield curve is a concept comparing current short rates to current 5- and 10-year rates.
What my chart does is to compare current short rates to the Treasury’s average intermediate term "coupon," a more reliable and indicative indicator of economic pain or restrictiveness since it uses an average embedded cost of debt concept instead of a current cost. The standard flatness as measured by current market rates in early 1995 (not shown here) never led to a recession, only a slowdown, just as Chart I would have indicated. In other words, this indicator called for a mild slowdown in 1995 which is what we got.
The standard flat curve theory called for something more extreme which is something we never got. The embedded cost of debt indicator, therefore, shown in Chart I, has been more reliable."
Gross’ conclusion? A US recession and a Bond market rally:
"The current data point in Chart I
is not only calling for an end to the bear bond market, but a recession
at some point 12-18 months hence. . . Hopefully you can take solace from a new timing indicator that says the
worst is over for bonds"
That’s consistent with my own views on the matters, but via a very different methodology . . .
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Source:
A Gift That Should Keep on Giving
Investment Outlook
Bill Gross | January 2006
http://www.pimco.com/LeftNav/Late+Breaking+Commentary/
IO/2006/IO+January+2006.htm
Barry– maybe you should include that incredible DOW 5000 call he made as equities bottomed in 03. I know Gross is one smart cookie but so is Buffett and he lost a billion and change shorting the greenback last year. I think Jeff Cooper on Real Money has it right– when you start thinking to much about big picture macro issues instead of following the money, you get your ass handed to you.
fantastic blog Barry!! thanks
erez raz
No doubt — he should stick to bonds.
Equities aren’t exactly his thing
Gross and Buffett had made much, much,much more money than they’ve lost.
So to disparage their thinking is pretty small-minded.
Keep in mind that Bill is an ‘early’ investor so 2 years might be closer to the mark.
Great blog, which I read frequently.
For what it is worth, here is the full quote from which the snippet at the end of the “Bill Gross Bond Timing Tool” posting is taken:
Observant readers will have already noted that the current data point in Chart I is not only calling for an end to the bear bond market, but a recession at some point 12-18 months hence. Perhaps. Much will depend on the future condition of the U.S. housing market and of course global economies – primarily of the Asian variety. We shall see. But for now, hopefully you can take solace from a new timing indicator that says the worst is over for bonds and an indicator that should keep on giving in terms of its reliability for years and years to come. Enjoy and Happy New Year…for bonds!
It is worth noting in this regard that both Gross and McCulley think the housing market is going to soften sigificantly, and according to Stratfor (www.stratfor.com), the Chinese economy is in for some rough times ahead. In Sunday’s LA Times business section appeared an article about the popping of the Shanghai housing bubble, with extensive quotation of commentary from Andy Xie of Morgan Stanley (who also I believe thinks China is due for a drop).
For those who focus blindly on fundamentals you will miss what is “really happening” with price action. Treasurys couldn’t rally on the bullish unemployment report on Friday and T-Note yield has been rising slowly from 4.379% (Friday) to 4.428% today.
A daily close above 4.45% will constitute a breakout on the daily chart with 4.55% as the next target. T-Note is in a downtrend!
Trading legend Richard Dennis once asked his students what they would do if they are long a market but subsequently found out that he is short the same market? Those who answered they will change their positions to that of their teacher’s failed the test.
Moral of the story – you have got to be able to think for yourself in markets. Doesn’t matter what Dennis or Gross is saying or doing.
treadmill
Gross has been calling for a recession for a long, long time now – many months. And he has also been calling for a rally in bonds for just as long. He keeps getting more and more explicit about his calls – as the market doesn’t seem to go his way.
While he might finally be correct, there is one issue I have with both his and McCulley’s views. They don’t seem to think that inflation is a threat. What happens if Oil goes through $70, Gold goes through $600, all the other commodities continue to take off, and the economy slows?? This is a very real possibility, and the Fed will have to raise rates (even as the economy slows) to fight inflation? But will they?
The sceptic in me always takes Gross’ views with a grain of salt. Remember, he’s selling bond funds, so he needs to make the argument bonds are a good investment!!