Tuesday, April 29, 2008

Bill Gross' investment outlook for May 2008

Bill Gross in his investment outlook for May 2008, All Quiet on the Western Front, outlines PIMCO's battle plan for investment in this bullet riddled economy. It is important because it sums up the difficulties and challenges that lay ahead for pros and ordinary investors alike. He cites his Co-CIO Mohamed El-Erian, who attributes the recent "euphoric moves" in equity prices and credit market spreads to a natural culmination of the deleveraging process in the financial system and to the restoration of liquidity by "previously unthinkable" policy responses. He agrees with El-Erian that this euphoria might be premature. One possible outcome might be a "Minsky Moment" named after economist Hyman Minsky.

Minsky proposed that speculative investment bubbles are endogenous to financial markets. The bubbles eventually deflate and together make up the normal life cycle of an economy. In 1974 he wrote, "The financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycles."

Gross and his friends at PIMCO believe that home price deflation has the potential to a Minsky moment and could be ruinous to the economy. "Its deflationary thrust must be countered or else the battle might be lost." If this happens the financial markets could turn down once again instead of up.

Minsky, McCulley, El-Erian, Gross, Feldstein, Summers, and a host of others would likely argue that additional policy measures are required to support home prices which have fallen by 10% over the past 12 months and are set for a repeat by this time in 2009. Lower Fed Funds? They would, in PIMCO’s opinion, likely do more damage than good from this point forward.

The better alternative is to initiate a limited mark-to-market write-down of private mortgage debt as envisioned in the Dodd-Frank Congressional proposal combined with government-subsidized loans at below market rates.

Surely Republicans, Democrats, AND Wall Street mortgage holders (PIMCO included) can recognize that stability as opposed to freefall market clearing is the better alternative, especially if the pain is shared by all parties. It is our best chance to cushion Minsky’s asset-based deflation.

It is somewhat ironical to see how structured financial engineering has been introduced in order to capitalize on the alleged advantage of "sharing the risk", and the failure of this concept at the market place now requires the same financial institutions to share the inflicted pain in order to restore stability. It remains to be seen if the authorities are willing to make the right decisions.



source: All Quiet on the Western Front
Investment Outlook
Bill Gross | May 2008
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/IO+May+2008.htm

source: Hyman Minsky
From Wikipedia, the free encyclopedia
http://en.wikipedia.org/wiki/Hyman_Minsky

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