Last week Bill Gross came out with his monthly investment outlook entitled “Credit Supernova”. Below is a summary of the outlook, and my explanation of the 3 primary investment ideas he gives in the piece.
So, what is a credit supernova?
Google gives the following definition for a supernova
“A star that suddenly increases greatly in brightness because of a catastrophic explosion that ejects most of its mass.”
Gross sums up why he is comparing our current debt situation to a supernova in the following paragraph and the chart below it:
“Today, at $56 trillion and counting, it is a monster that requires perpetually increasing amounts of fuel, a supernova star that expands and expands, yet, in the process begins to consume itself. Each additional dollar of credit seems to create less and less heat. 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.”
So does Gross think the credit system is about to end in a catastrophic explosion? Not exactly. As he states later in his commentary:
“I will admit that my supernova metaphor is more instructive than literal. The end of the global monetary system is not nigh. But the entropic characterization is most illustrative.”
So what is an investor to do with this information?
Here are the three main investment ideas Gross gives in his outlook and my explanation of each:
Investment Idea 1: Buy TIPS and short duration bonds to position for eventual inflation.
Treasury inflation protected securities or TIPS for short are designed to offer inflation protection by adjusting their principal value up and down with the level of inflation. You can learn more about buying TIPS here.
Unlike TIPS, short duration bonds do not offer direct inflation protection. They do however minimize your interest rate risk, which is the risk that the value of your bonds will fall as interest rates rise. The shorter a bond’s duration, the lower the impact of a rise in interest rates will be. Secondly, short duration bonds mature faster than long duration bonds, allowing you to reinvest at higher rates that will result once inflation hits. You can learn more about duration here and see a chart of inflation here.
Investment idea 2: Invest in the currencies and the assets of countries with lower debt levels and less “hyperbolic” credit systems. Gross gives the examples of Australia, Brazil, Mexico, and Canada.
Its an interesting time in history, as many developed economies such as the United States and Japan have exploding levels of debt. Their growth has also suffered tremendously as a result of the financial crisis. At the same time many developing and emerging economies not only have much lower levels of debt, but were not damaged nearly as much as many developed economies by the recent financial crisis.
As a result of this “changing of the guard” the currencies of those countries should be stronger than those of more indebted developed economies. They should also experience higher levels of growth, which should translate into increasing stock prices.
Many developing economies also have positive real interest rates, meaning that you can earn a return on their bonds over and above the rate of inflation. This is not true currently in the United States, where we have negative real interest rates, basically guaranteeing that the income generated from US government bonds will not outpace the rate of inflation. For sovereign bonds to consider, gross specifically points out Mexico, Italy, and Brazil.
You can read more about investing in developing and emerging economies here.
Investment Idea 3: Buy hard assets like gold, commodities, real estate and “anything that can’t be produced as fast as credit”
This one is pretty self explanatory. In an environment of increasing inflation, hard assets tend to do well, because there is a finite amount of the hard assets being chased by an ever increasing supply of money.
You can read more about Gross’s view on hard assets here.Want to learn how to generate more income from your portfolio so you can live better? Get our free guide to income investing here.