The Newport Beach Whale
PIMCO bond boss Bill Gross provided his “Investment Outlook” for June, reiterating his “Plankton Theory”, which states that the whale depends on plankton for survival.
In the financial world, the whales are large bodies like banks and the Fed while the plankton are smaller investors. Gross notes that “the balance between the financial whales and plankton – powerful creditors and much smaller debtors – is significantly dependent on the successful functioning of our global monetary system.” That said, he believes we may have reached a point where the system can no longer operate efficiently and equitably to promote growth and ensure a fair distribution of benefits.
Policy responses since 2008 have managed to prevent a substantial reduction in the global monetary system, but in turn have increased the risk and lowered the return of sovereign debt securities. Gross notes that the lower quality and yields of debt represent a breaking point in the system. With the U.S. credit downgrade, he believes the willingness of creditor “whales” to support the system may soon descend. He points to China, who could at any time choose to shift Treasury holdings to higher returning real assets which may result in a reconfiguration of the dollar based credit system.
The end result could be a shift away from the current fiat-based monetary system.
What is an investor to do? Gross suggests bond investors should favor “clean dirty shirt” sovereigns such as the U.S., Mexico, and Brazil while focusing on intermediate maturities that gradually shorten over the next few years. Equity investors, he says, should look to stable cash flow global companies and ones exposed to high growth markets. In general, Gross believes that investors will be hard pressed to repeat the strong performance of the past 30 years as deleveraging economies and financial markets present a different kettle of fish, which should lower return expectations.