Last week, bond investor extraordinaire Bill Gross reportedly plunked down $23 million in cash to buy a tear-down home on Harbor Island in Newport Beach, Ca. Gross, managing director of the big PIMCO investment-management firm, is not only a rich guy but a smart guy. His take on our economic future is worth pondering, in no small part because he earned credibility by successfully navigating the mortgage and market meltdowns. And while there is merit in polling 100 economists and market mavens to produce a consensus forecast, it can be equally valuable to listen to one clear voice. And what Gross is saying, very clearly, is that we are in for a prolonged period of slower growth.
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Since World War II, he writes in his August investment outlook, the U.S. economy achieved an effective 5 percent growth path. Over time, businesses and investment markets became geared to expect such performance and, in fact, their behaviors were instrumental in perpetuating it: "Businesses expanded with a developing certainty that demand, expenses, and return on the economy’s capital would mimic this 5 percent consistency. Debt was issued with yields that reflected the ability to service those payments through 5 percent growth in both real and inflationary terms, and stocks were issued and priced as well with the same foundation. Pension obligations and similar liabilities were legitimized on comparable logic, as were government spending programs forecasting tax revenues and benefits. Both real economy and financial markets then, were geared to and, in fact, mesmerized by this 5 percent . . . 'model.' "
A system based on 5 percent growth is clearly in shock when it confronts not only much lower growth but actual declines in economic activity. Can government stimulus and a zero interest-rate policy from the Federal Reserve get us back to that 5 percent path? Gross doesn't see it, and the rising chorus of concern about unsustainable federal deficits supports his view that current stimulus efforts cannot be sustained. Looked at this way, an outlook for sustained lower growth amounts to a death sentence for many companies and employees. "If allowed to continue—and this is my critical point—a portion of the U.S. production capacity and labor market will have to be permanently laid off," Gross says. "Nominal GDP has to grow close to 5 percent in order for the economy’s long-term balance to be maintained. Otherwise, employment levels become unsustainable, retail shopping centers unserviceable, automobile production facilities unprofitable, and the economy itself heads towards a new normal where unemployment averages 8 instead of 5 percent, housing starts total 1.5 instead of 2 million, and domestic auto sales 12, instead of 16 million annual units."
Gross sees a future path that looks much more like 3 percent annual growth than 5 percent—small numbers with huge implications. "A 3 percent nominal GDP [Gross Domestic Product] 'new normal' means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector, which substantially changes the character of the American capitalistic model," he writes.
In terms of specific types of investments, Gross does not see happy times. "High risk bonds, commercial real estate, and even lower quality municipal bonds may suffer more than cyclical defaults if not government supported," he writes. "Stock P/Es [price-earnings ratios] will rest at lower historical norms, and higher stock prices will ultimately depend on tangible earnings growth in the form of increased dividends, not green shoots hope."
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For many older people, a "prolonged" period of slower growth might just extend for the rest of their lives. Many if not most older folks don't need Bill Gross to tell them what might be in store. They have hunkered down for a long economic winter and have made what just may be permanent spending cuts in order to boost savings and extend the useful lives of their diminished retirement nest eggs. For retirees fortunate enough to have investment portfolios, the focus is on lower-risk holdings that offer at least some protection against a future bout of inflation that many see as unavoidable.
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