Bill Gross: Escaping the credit supernova

The economy and the universe are similar, says Bill Gross in his recent Investment Outlook column. They started with a big bang, and they will end with ever greater expansion, petering out trillions of years from now in a big freeze.

The depressing analogy was used by Gross, who runs the $270 billion  to illustrate his worries with expansive fiscal policy by the US Federal Reserve and governments around the world that cannot tame their spending.

"[Our] current monetary system seems to require perpetual expansion to maintain its existence. And too, the advancing entropy in the physical universe may in fact portend a similar decline of 'energy' and 'heat' within the credit markets," writes Gross.

He notes that the current credit outstanding is $56 trillion and counting, and every dollar added seems to generate less return.

"In the 1980s, it took four dollars of new credit to generate $1 of real GDP. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result," writes Gross.

Gross said the end is not "nigh" but investors can look for signs that a breakdown is happening: there will be too much money chasing to few investable assets and too much risk for too little return. For example, long-term bond yields will be too low relative to duration risk. Another sign is credit spreads that will be too tight relative to default risk.

Gross says there are steps investors can take to themselves and even make some money:

(1) Position for eventual inflation: The end stage of a supernova credit explosion is likely to produce more inflation than growth, and more chances of inflation as opposed to deflation. In bonds, buy inflation protection via TIPS; shorten maturities and durations; don’t fight central banks – anticipate them by buying what they buy first; look as well for offshore sovereign bonds with positive real interest rates (Mexico, Italy, Brazil, for example).

(2) Get used to slower real growth: QEs and zero-based interest rates have negative consequences. Move money to currencies and asset markets in countries with less debt and less hyperbolic credit systems. Australia, Brazil, Mexico and Canada are candidates.

(3) Invest in global equities with stable cash flows that should provide historically lower but relatively attractive returns.

(4) Transition from financial to real assets if possible at the margin: Buy something you can sink your teeth into – gold, other commodities, anything that can’t be reproduced as fast as credit.

(5) Be cognizant of property rights and confiscatory policies in all governments.

(6) Appreciate the supernova characterization of our current credit system. At some point it will transition to something else.

Read the full report here>>

Image of a supernova by ernenn