Bill Gross on the End of the Great Bond Bull Market

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1:27Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, we are at the Future Proof Conference in the glorious Huntington Beach, and we have a very, very special guest. This is something that we recorded live, on stage, on a beach. We've never done that before. Never on a beach before. Truly extraordinary moment. Beautiful Huntington Beach. It really is kind of like a festival here, and this was a really fun conversation to do. Yep. So we are speaking with Bill Gross, the bond king himself. Obviously, he has a lot of thoughts on the state of the bond market now, but we're also going to talk to him about his career and how investing and trading debt has actually changed over the decades.

2:12Yeah. Really fun conversation. Take a listen. Bill, you brought out the sunglasses, huh? I did. It's been 10 years. Last time it didn't work too well, but... Try it again. Yeah, we'll try it again. It'll be good this time. I want to start out with, you know, we're in the midst of what seems like another interest rate cycle of some sort. No one really knows how long it's going to last. There aren't that many people around nowadays who have lived through different interest rate cycles. And you actually started your career in the 1970s in an era of stagflation, in an era where the Fed was hiking.

2:50We didn't have derivatives to hedge duration risk. We didn't have Bloomberg terminals. We had Quotrons. What was that like? Well, it was much different. You know, bear markets are not as much fun as bull markets, depending upon your position. But, you know, interest rates got to 15 % and 81, 82, somewhere in there. And the interesting thing is that they were almost self-hedging because the duration of a 30-year treasury at 15 % was about four and a half to five years. It was like a five-year today or close to it. And so at 15 % with a very short duration, it meant that interest rates could go up to 18 % and you still wouldn't lose money.

3:39It was a golden opportunity. be. When you think back and, you know, obviously, as Tracy mentioned, you started at PIMCO in the early 70s. And so there were several years of bond bear market before the great bull market, which we'll talk about. What did you learn then about like surviving in a bear market for an asset class? Well, you know, it depends on who you're investing for. If you're looking for a client and trying to glow a business, then you have to be aware that relative performance is important, but if it's a significant bear market, that absolute performance is crucial as well. Investors and clients will just leave no matter how good you were relative to the market.

4:32So I think that was key back then, relative performance, and then stepping on the accelerator in 81, 82 and buying a secular bull market. And it was a bull market. So nowadays, we kind of take for granted that people actively trade bonds. You buy and sell them. But when you started out, that wasn't the case at all. Walk us through the thought process and the opportunity that you saw in trading bonds. Right. Well, there were no real computers, no clearinghouse overnight types of trades. As a matter of fact, at PIMCO, which was owned by Pacific Mutual downtown L.A., we had a billion dollars in a vault.

5:25And I was hired not for PIMCO, but really for private placements. And one of my jobs, 25 % of the$11 ,000 I made each year, was to go down into the vault and to actually clip coupons. You've heard of coupon clipping? I did a lot of that. And back in the day, because the bonds were in the vault, it was pretty hard to get them to New York. It took two or three days to get them to New York. Like I say, there were IBM 360s, but nothing in terms of connectivity. And so the physical trading of bonds and stocks was very difficult and allowed for illiquid markets. Talk to us more about, you mentioned 81, and then you pressed down on the accelerator and rode this incredible wave, right?

6:26This incredible, roughly, I guess, 40-year, basically, bull market in bonds. But talk to us, you know, if you look at your career and you think the bond king, like, talk to you about the role of timing and how crucial that was. And when you think about the success that you had at PIMCO, et cetera, like, just the being there at the right time and the role of, I guess, a little bit of luck. Right. Well, the key at PIMCO for us at PIMCO, it wasn't just me. We had a lot of smart people and more and more as time went on. But the key was really a book that, I forget who wrote it, it was called Investing for the Long Term.

7:09It was about stocks. But it mentioned the long term, the secular movement of financial instruments, as opposed to cyclical, as opposed to short term trading. And it seemed to me that the bane of investor is emotion. And I'm the same way. I never thought of myself as a good trader. I mean, if NVIDIA, you know, hits 500, I'm just as likely to buy it as to sell it and then regret it the next day. But in any case, if you take a longer-term view and not go to sleep, but if you take a longer-term view and know that forces in the economy, inflation, demographics, globalization, if you know that those are working in the favor of either a bull or a bear, then sticking with what we call a three - to five-year forecast as opposed to a three to five day forecast was the key.

8:17And does it hurt mentally when you're long and you should be short for a short period of time? Yeah, it does. But you just, you have to stay with that mind frame of a longer term secular market. How did the way you traded actually change as PIMCO grew larger? Because I imagine, you know, at one point, PIMCO has hundreds of billions of dollars under management, trillions even. And there are pros and cons to that, right? Like, you get first allocation of debt, but maybe it's hard to hug your benchmark because you are gigantic. And that's true. As we grew, larger and larger clients would always say, well, how can you keep doing this at$100 billion or$200 billion or$500 billion because your size is prohibitive in terms of liquidity?

9:18It wasn't because we found the futures market, we found the foreign markets, we found markets that added liquidity. And actually, we'd stay in this trading room, and this is not a good joke for now, but I'll tell it anyway. The client would say, how can you do it? and then we'd tell them how we did it. And then we'd go back in the trading room and look at each other and they'd say, you know how we do it? We just add a zero to the ticket. Yeah, it's that simple. Just add a zero to the ticket. I know we're going to talk, we're going to, you know, at some point, like talk about this current market a little bit, but maybe as like a sort of seg, you know, obviously there were a lot of, in the inflation of the late 70s and early 80s, there were a lot of false dawns, right?

10:14Where they thought they had defeated inflation and the Fed was like, okay, we're going to be able to bring rates down. And then inflation shot up, and it took them a long time before it was good for good. Does it feel today similar to that, or does it feel like the late 70s, this inflation, or does it feel like substantively different, what we've experienced over the last few years? Well, the late 70s was influenced by 71, 72, when Nixon went off the gold standard, and it was easier and then easy for central banks to print money. There was also OPEC, and once it got going, it was hard to stop.

10:54You know, I think the Fed and other central bankers are more aware now. Hopefully they are. They weren't two years ago, so it's hard to make that claim. But it's a market these days that can be controlled to some extent with higher interest rates, but not necessarily. Not necessarily. And we're seeing that right now because the real five-year note, the real five-year note in terms of interest rates was bottomed at minus 200 basis points. It's now plus 250. It's gone up 450 basis points in the last year and a half, which is incredible. And to my way of thinking, when we start talking about stocks, it's definitely a negative influence in terms of valuations and PEs, but the market doesn't seem to recognize it.

11:55Wait, when you say the economy can't be controlled through interest rates as much as it once maybe could be, can you expound on that? Why is that the case? Well, you've got foreign markets, which didn't exist really in size back then, and they have an influence on the treasure market, although it's usually the other way around and pretty decent size. and you've got demographics that are important now with the boomers, myself and others, that are spending their savings and that has a significant effect in terms of supply relative to demand. You didn't have that demographic influence back then. And then globalization crept up in the last 10 years or so made for higher productivity, and now it's going the other way.

12:57So there are just other forces to think about, and that's what Powell is doing. He's trying to gauge the appropriate real interest rate that will produce 2 % inflation, which I think is a dream, but that's what he says he's going to do, and that's what he tries to do, and that's why Fed funds are five and a quarter to five and a half. We'll see what happens.

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14:56Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokered services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA and SIPC. Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. A lot of people think that rate cuts are coming, that we're at some abnormally high level of interest rates, and it's only a matter of time before the Fed is able to normalize.

15:34and by normalized, what they mean is cut, to something that maybe would be more familiar in the, not go back to ZERP, but something that may be more familiar several years ago. Do you see that in the cards? Do you think the Fed is going to be able to cut sometime soon and rates are going to come back down? Yeah, I don't think so unless recession comes with a capital R and it doesn't seem to be doing that. Let me give you my valuation metric for the 10-year, the 10-year at four and a quarter for treasuries. So Powell wants to get Fed funds down to two. Let's say it's successful. Let's say Powell is successful, which would be seemingly very bullish for the market.

16:14And if Fed funds are at two, and then the R star, as they call it, the real Fed funds rate would be at two and a half. But then there's a term premium, Joe. a term premium that historically has been about 130 basis points over Fed funds. And we're talking about the term premium of the 10 versus the short-term rate. And why is there a premium for a 10 versus a short-term rate? Because it's riskier because it goes up and down and you can lose money, whereas you can't with a bill. So let's just say that Powell is successful, gets to two. Our star is at two and a half term premium, three and a half, close to four.

16:56I mean, at four and a quarter, we're basically anticipating the Fed being successful and containing inflation at a 2 % level. And if he doesn't, then we certainly haven't got a bull market, and we certainly don't have a context where Powell and the Fed are likely to cut interest rates. I just don't see it. It's not that I'm significantly bearish, although we can talk about that in a second. But four and a quarter is not a bad level for now as long as inflation keeps going down. If it doesn't, then no, no. I'm going to take you up on the bearishness offer in a second. But since you mentioned the term premium, when you look at the yield curve right now, the fact that it's inverted, what do you see?

17:51What's that telling you? Because I feel like there's a group of people who will say this time definitely isn't different. It's a traditional indicator of recession. And then there are a lot of people who will say times have changed. The term premium is a lot lower than it used to be. Maybe that's what's causing the inversion. Well, I think it is. That's another way of saying that the term premium, which appears to be close to zero is wrong. But I've been baffled by the length and the extent of the negative curve. I mean, we had one in 79, 80, 81, and it seemed to work for Volcker. It doesn't seem to be working that well now.

18:40And I think perhaps one of the reasons is that fiscal policy has been so expansive. I mean, we're looking at a$2 trillion deficit this year. Last year it was three, three and a half during COVID. And so, you know, when you have fiscal policy in such a deficit and people spending money, it's like Bernanke. Remember Bernanke with a helicopter? I'll be damned, but that's what we did. We threw money out of a helicopter. We threw trillions of dollars out of a helicopter. And so the last of it is just now being spent. And I think the reason why term premiums are so low is that the economy is good and people have money to invest.

19:33All right, I'm going to jump. What do you, you said, you hinted, or maybe there's something that you're bearish on. What do you bearish on? You mean in terms of markets? I don't know. You said not bearish, and then you're like, oh, I'll get back to that. Oh, well, in terms of bonds, so we have a deficit of close to$2 trillion. The outstanding treasury market is about$33 trillion. I've read on Bloomberg and others. Very reputable outlet. Thank you. Thanks for the plug. And other sources that basically say about 30 % of the existing outstanding treasuries, that's$33 trillion, so$10 trillion, have to be rolled over in the next 12 months, including the$2 trillion that's new.

20:21So that's$12 trillion worth of treasuries that have to be financed over the next 12 months. And who's going to buy them at these levels? Well, some people are buying them, but it just seems to be a lot of money. And when you add on to that, that Powell is doing quantitative tightening, as you know, and that theoretically is a trillion dollars worth of reduced, well, a trillion dollars worth of added supply, I guess. And so it just seems like a very dangerous time based on supply, even if inflation does come down. So I wouldn't necessarily be bearish because I think the Fed talks a good game, even though they don't play a good game.

21:14They talk a good game, and they seem to have convinced investors that interest rates will come down once we get close to 2%. I think that's a stretch. You know, given that deluge of supply and the fact that you are going to need a lot more buyers to take that up at exactly the time when it seems like a lot of traditional foreign buyers of U.S. debt have have stepped away. Do you think financial repression comes back into play? We're already seeing the Fed talk about higher capital rules for some of the banks, things like that. Is that a risk in your mind? I remember you talking about this way back in 2011, 2012.

21:56Well, I think it is. All of the new rules, you know, in terms of the intermediate banks, which followed on from Silicon Valley Bank, the new rules. And Schwab, by the way, if Schwab's out there. Chuck and I play golf once in a while, so sorry about that. The banks have gone overboard in terms of duration. I mean, Schwab basically takes all their money market instruments and not all, sorry, but a lot and puts it into long-term bonds. And that's how they've gotten caught. And that's how Silicon Valley got caught. And so, you know, the repression hasn't necessarily, in terms of what I read, come in the form of duration.

22:44But it's come in the form of increased capital and increased debt. A lot of these intermediate banks have been ordered or will be ordered to issue$6 or$7 billion worth of debt in order to absorb what happened 6 to 12 months ago. So I think that's an effect of what we have. We have a financial system that's dependent upon asset prices going up. If you remember anything I said today, we have an economy that's based on asset prices going up. If they don't go up, there are problems. There are problems because there's so much debt and there's such high expectations in terms of P.E. ratios and the like that if this asset-based economy, which depends upon higher stock prices, depends upon higher or relatively high bond prices, it's precarious at some point.

23:57I'm not saying get out. I'm just saying that assets have to go up or else the economy will not do well. Since you mentioned duration, how would you manage or hedge duration risk right now? And you can't just say that you wouldn't take it on. If I gave you$100 to invest in bonds, how would you hedge that duration risk? You know, PIMCO was always successful. Most people didn't realize it until the books came out. PIMCO was always a great believer in selling volatility. Selling volatility has an alpha, pretty consistent alpha over time, momentum. It doesn't always work, obviously, when black swans appear.

24:43But momentum is like an insurance company. And so that's the way Buffett works. Buffett doesn't say that's the way it works, but that's the way it works. He takes that float and he sells volatility by investing in longer term stock options, et cetera, et cetera. I would, and what have I done? I would sell a put and a call on, say, a 10-year treasury. The TY contract, TYZ3, trades at around 109. You know, I just sell 108 put, 110 call for 30 days, and the volatility is decent, not as high as it has been, but it's decent. And you just bring those premiums down to the bottom line as long as the market doesn't take off like a firecracker one way or the other.

25:32So Tracy posed this hypothetical to you. It's like, okay, how would you hedge this duration? But listening to, I'm just wondering, why should anyone buy a bond? And the reason, as you said, the long end is almost already priced in a sort of success from the Fed, like already pricing in a sort of good scenario. There's upside risk. There's this deluge of issuance. and unlike say for the last at least the last 15 years going up until 2021 and longer like we're not even getting these sort of like inverse correlation to equities in the portfolio so you no longer get that sort of like beautiful 60 40 portfolio where something in your portfolio is green on the day and green on the quarter so is why why own a bond well that's a good question So say you buy a 10-year Apple or 10-year Amazon, you know, at five and a quarter, plus or minus.

26:29And this is, you know, I've been in this business a long time. And I've been tax sensitive, but I haven't, I'm not a real estate guy. All my buddies at the country club are in real estate. And they've never paid a tax in their life. and they think you're a fool for having paid taxes so i'm thinking about this and and so i've paid a lot of taxes so it's so say you earned uh five and a half from an amazon 10 year um and say you live in california or new york to say so that's a 15 hook right there and the federal uh is probably 40 plus or minus depending upon what your bracket is so so take it up to 55 so So the government takes 55 of the 550, and 55 times 550, 55, it's probably like 6, well, 55 times 55 is like 625, whatever.

27:33You start to lose it when you're 79. Anyway, so the government's taking like 55 % right away. And say you're trying to build an estate, lead something for your grandkids, and yeah, you can set up a trust, et cetera, et cetera, but that costs money too. But the estate tax is 40%. And so if you've got 45 left and you've got 40 % on the estate tax, that's 16%, 17%. And so you're basically up to 70 % that that government takes. That government takes 70 % of your money, and you get 30%. And so why would you risk 100 % of your money for a 30 % payoff at five and a half? It doesn't make any sense. And it certainly didn't make any sense two years ago or a year and a half ago when interest rates were zero.

28:28So you've got to beat the tax man in one form or another. I'm not a pro at that. Go buy an office building in New York, I guess. I don't know. I've heard they have their own problems. The office buildings in New York. Just a few. Bill, you kind of alluded to this, but you're managing your own money now, and you're invested in a lot of different things. So stocks, bonds, MLPs. What's your favorite thing to trade now? Well, the best idea, unfortunately, you know, oil is at a cyclical peak. Maybe it goes higher. I hope it does. but there's master limited partnerships mainly in the oil and gas pipeline areas at some point 10-15 years ago congress somebody paid off a congressman and he inserted it into a bill and so mlps you know basically are partnerships just like real estate it's the way it's a way to get even with your real estate golf buddies.

29:38And so what it is is that you don't pay any taxes until you sell it, okay? Just like real estate, they don't pay any taxes. Even when real estate guys sell it, they transfer it to another property, they don't pay any taxes. They don't pay taxes ever. Anyway, so these MLPs, and there are about six or seven or eight of them, they trade pretty frequently. The largest one is called Energy Transfer. It's ET. It's the biggest in the country. It yields 9%. And is that safe? It's been pretty steady. And is it dependent upon oil prices? Yeah, the price of the stock is affected to some extent if oil goes down.

30:18So I've got an MLP with energy transfer at 9 % yield that I don't pay taxes on until I sell it or it pops into an estate and I don't think you even get taxed then. And all of these MLPs are like eight, eight and a half, nine percent. And you know, that suggests that there's a lot of risk there. And I suppose there is. They've gone down and they'll go down again. But from a tax standpoint, I really like them. And about 40 % of my portfolios are in oil and gas MLPs. Other symbols would be MMP, Magellan, MPLX, NS, Newstar. There's like eight of them. Just get your Bloomberg and hit RV for relative value, and it'll show you everything you should invest in.

31:11We asked Bill to give you tips on terminal functions. No, I love, so I love, like, you know, the exact price of the part of the treasury futures curve where it's trading right now. It varies tickers in their yields of MLPs. So you're still like, you're getting up at 530 every day still and just as active as ever. Yeah. And I know that's sort of stupid and people say, smell the roses. And I, I think I do. My wife, Amy, and I play golf in the afternoon that, that, that's smelling the roses, but in the morning, what else would I do? I'm not going to watch the morning talk shows. And so, yeah, I get up and I watch the market and it's fun.

31:56I told you this backstage, but there's a good definition of happiness. It's not the only definition. You've got plenty, I'm sure, but one definition says you need someone to love. That's for sure. You need something to do and something to look forward to. And so for me, the market is something to do in the morning and something to look forward to. I look forward to NVIDIA and the earnings announcement. I'm hanging at 1 o 'clock Pacific time just waiting for that announcement. And I go, what are you doing? Why is this so important to you? But I guess it is. I love that of the three things you need to be having, the market is two of them for you.

32:42All right. Well, on a related note, I remember in one of your very famous investment outlooks, you said that you didn't consider yourself a good trader. So fast forward many years. Do you think you're a good trader now? Have you gotten better? No, I'm not a good trader. I'm as emotional as everybody else. And that's the problem. You can't be emotional. And so, you know, take Buffett. Buffett's not emotional. He's funny. he's a great personality but I don't see him as an emotional person he's just dried dried in terms of how he looks at markets and the timing he looks at markets going forward and so it kicks the emotion out of there yes he's got to be right if he thinks the market's going up or going down he's got to be right on a long term but the emotion's out of there and so you know I found for myself I'm very emotional.