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2007--3% Nominal Growth and Lower Asset Prices

 
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PostPosted: Sat Jan 13, 2007 9:09 am    Post subject: 2007--3% Nominal Growth and Lower Asset Prices Reply with quote

Bloomberg's Tom Keene: "Bill [Gross], your note every month is always interesting. This last one is one of my favorites. As you know, I'm a big fan of nominal GDP - this, folks, is real GDP plus inflation. It's the 'animal spirits' that's out there. You say be careful, Bill Gross. It looks real good to me, Bill. I see 6% year-over-year nominal. You say that's going to end?"

Pimco's Bill Gross: "I think almost assuredly, because of oil prices. I'm not suggesting it end because of real growth going down - that's the Goldilocks scenario in which we have 2% plus or minus real growth. With oil prices doing what they're doing - if they hold in the $55 range - gosh, we're going to see CPI prints y-o-y over the next three or four months of 0.5% or 1.0% and that means nominal GDP is down in the 3% range."

Tom Keene: "And the important distinction here is you have two moving parts: GDP and inflation. So you've got roughly four outcomes: They both go up, they both go down, or they split the difference. You're suggesting - your focus - is more on the inflation part of nominal GDP or are you looking equally at the growth dynamics?"

Bill Gross: "Ultimately, the inflation component affects the real growth component. To the extend that you have nominal GDP - in my forecast 3 to 3.5%, that's really not enough growth in terms of the economy itself to support asset prices at existing levels. And so, declining assets prices ultimately factor into eventually lower real growth. But that's not for mid-2007 but perhaps for later in the year."

Tom Keene: "When we look at six months of low nominal GDP, is that enough to link directly into the 'animal spirits" of the business investment component of GDP - the "animal spirits" of business men and women?"

Bill Gross: "Well sure it is. When you realize that the average cost of debt in the bond market - and therefore in the economy and this includes mortgages - it is about 5.5%. If you can only grow your wealth and service that debt at 3.5% rate, then that has serious implications. When you go back to 1965, Merrill [Lynch] did this study - in terms of asset prices during periods of time when nominal growth grew less than 4%. Risk assets have been negative in terms of their appreciation and actually bonds have done pretty well. The question becomes why hasn't that happened yet, and I think we're simply in a period of time where there are leads and lags that are much like the leads and lags of Federal Reserve policy."

Tom Keene: "Where will the 10-year yield be 12 months from now?"

Bill Gross: "I think around 4.5%, and that's not a dramatic bull market, Tom. We're at 4.75% now and that would imply a point and a half of price appreciation on top of that yield, so maybe a 6% total return. But we're definitely moving into a period of time during which bonds begin to do better. Obviously, in the last month or two they have not, and risk assets - typified by equities - have done just the reverse. But I think we're beginning to get into a period in which this tightening effect will move things in the opposite direction."
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