Bill Gross of PIMCO thinks Treasuries and high-yield bonds will do well as investor become risk averse, which is a reasonable bet, says David Zervos, Head of Global Fixed Income Strategy at Jefferies.
Gross probably believes quantitative easing does little good for the real economy and that’s where the subtle difference of opinion lies, he added. In the end, the equity market is going to do well even if quantitative easing generated too much of inflation and not enough of real growth.
For the equity market, it doesn’t matter whether the Fed gets its move right and gets investors take more risk to generate real returns on real capital because higher inflation will drive equities higher which can be used as a hedge against inflation.
For bonds it becomes a little tricky when there’s excess inflation in the future as returns take a hit.
Should investors avoid assets that can be diluted through money printing like bonds and focus more on those that can’t be diluted? David said there are two types of asset classes in the world, those that can be printed and those that can’t be printed. Assets like bank accounts, T-bills and cash get diluted as the Fed prints more money to buy mortgage-backed securities.
The same policy is being followed by the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank. Physical assets like real-estate and shares of companies like Caterpillar are immune to inflation. Commodities also perform well in an inflationary environment whereas for low-yielding bonds that don’t have many credit enhancements built into it, inflation poses a major risk and yields will be eaten away over time due to the inflationary policies of the central banks.
Asked if the Federal Reserve is encouraging more inflation, David said the Fed is taking the risk of more inflation in the medium term than in the long term. If the Fed doesn’t take the risk, they may end up with a deflationary outcome which may prove terrible for the economy, especially with such high levels of debt. The Fed will prefer a scenario similar to the 1970s over a Great Depression like scenario of the 1930s. You can watch the video here.