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Friday, April 08, 2005


not with a bang but a whimper

when bill gross quotes t.s. eliot, things are bleak.

The fact is that this real interest rate journey to its current destination has pumped up all asset prices because they are all being discounted by an extremely low real interest rate. The current level has produced double-digit annual rates of appreciation for different asset classes at varying cycles—stocks and bonds first—commodities, collectibles and housing with a lag. The important point and critical element in a future forecast, however, is to recognize that real yields, whether they be short-term or further out the curve, bottomed in 2003 and have been moving higher ever since. Not only has the downward journey ended, but a mini up-cycle appears to be underway which ultimately reduces bond prices, stock P/Es and casts a negative pall on other asset classes.

Since the PIMCO forecast is for real yields to stay low, absent a policy mistake by the Fed, we may well whimper along rather slowly as all asset classes compress to provide 2-3 percent real and 5+ percent nominal returns over long periods of time. We remain mindful, however, of not only potential central bank errors of judgment, but of oil, currency and geopolitical sparks that could produce a calamitous Big Bang in a highly levered, finance-based economy. High quality bonds, and especially those with inflationary protection, remain the bond market’s best bet absent a wormhole to a warmer and more inviting universe.

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