Bond investor Bill Gross warned on Thursday that investors should not be tempted into buying high-flying equities and corporate bonds, given the possibility that U.S. President Donald Trump might fail to enact policies that fuel economic growth.
Wall Street’s main indexes have rallied since Trump was elected president and remain close to all-time highs, driven by optimism that his policies may stimulate growth in various industries and push share prices even higher.
“Don’t be allured by the Trump mirage of 3-4 percent growth and the magical benefits of tax cuts and deregulation,” Gross said in his latest Investment Outlook, which is released during the first week of every month.
“The U.S. and indeed the global economy is walking a fine line due to increasing leverage and the potential for too high (or too low) interest rates to wreak havoc on an increasingly stressed financial system. Be more concerned about the return of your money than the return on your money in 2017 and beyond.”
Gross, who runs the Janus Global Unconstrained Bond Fund, characterized the run-up as the “Trump bull market and the current ‘animal spirits’ that encourage risk.”
Details on Trump’s plans remain scarce, however, and equity gains have moderated on growing concerns that stock valuations may be high.
The S&P 500 is trading at about 18 times forward earnings estimates against the long-term average of about 15 times, according to Thomson Reuters data.
Gross said the global economy has created more credit relative to GDP than that at the beginning of 2008’s great credit recession.
“In the U.S., credit of $65 trillion is roughly 350 percent of annual GDP and the ratio is rising,” Gross said.
“In China, the ratio has more than doubled in the past decade to nearly 300 percent. Since 2007, China has added $24 trillion worth of debt to its collective balance sheet. Over the same period, the U.S. and Europe only added $12 trillion each.”
Gross said central banks are attempting to walk a fine line between generating mild credit growth that matches nominal GDP growth – “keeping the cost of credit at a yield that is not too high, nor too low, but just right. (Federal Reserve chair) Janet Yellen is a modern day Goldilocks.”
While Gross rated Yellen as “so far, so good, I suppose,” he said the U.S. recovery has been weak by historical standards. Yet banks and corporations have recapitalized, job growth has been steady and importantly – at least to the Fed – markets are in record territory, “suggesting happier days ahead.”
But Gross said “our highly levered financial system is like a truckload of nitro glycerin on a bumpy road. One mistake can set off a credit implosion where holders of stocks, high yield bonds, and yes, subprime mortgages all rush to the bank to claim its one and only dollar in the vault.”
It happened in 2008, Gross said, noting central banks were in a position to drastically lower yields and buy trillions of dollars via Quantitative Easing (QE) to prevent a run on the system.
“Today, central bank flexibility is not what it was back then,” Gross said. “Yields globally are near zero and in many cases, negative. Continuing QE programs by central banks are approaching limits as they buy up more and more existing debt, threatening repo markets and the day to day functioning of financial commerce.”
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