Bill Gross: Avoid bank stocks in neg­a­tive in­ter­est-rate world

The Pak Banker - - COM­PA­NIES/BOSS -

Bill Gross, the widely fol­lowed in­vestor who runs the Janus Global Un­con­strained Bond Fund, said Thurs­day in­vestors should not be tempted into buy­ing beaten-down bank stocks against a back­drop of in­ter­est rates po­ten­tially turn­ing neg­a­tive.

In his lat­est In­vest­ment Out­look re­port, Gross said neg­a­tive yields threaten bank profit mar­gins as yield curves flat­ten world­wide and banks' net in­ter­est rate mar­gins nar­row.

"The re­cent col­lapse in world­wide bank stock prices can be ex­plained not so much by po­ten­tial de­faults in the en­ergy/com­mod­ity com­plex, as by in­vestor recog­ni­tion that banks are now not only be­ing more tightly reg­u­lated, but that fu­ture Re­turn On Equity's will be much akin to a util­ity stock."

Gross noted the col­lapse in bank stock prices af­ter the col­lapse of Lehman Brothers in 2008: Citi was at $500 in 2007, cur­rently trades around $38; Bank of Amer­ica at $50 but now trades around $12; Credit Suisse was at $70 and now trades around $13; Deutsche Bank at $130, now around $16, and Gold­man Sachs was at $250, and is now at about $146.

Gross warned in­vestors: "Bank­ing/fi­nance seems to be ei­ther a scream­ing sec­tor ready to be bought or a per­ma­nently dam­aged vic­tim of write­offs, tighter reg­u­la­tion and sig­nif­i­cantly lower fu­ture mar­gins. I'll vote for the lat­ter."

Gross said in­vestors should not reach for the "tan­ta­liz­ing ap­ple of high yield or the low price/book ra­tio of bank stocks." Those prices are where they are be­cause of low or neg­a­tive in­ter­est rates, Gross said. Ad­di­tion­ally, in­vestors should not reach for the seem­ingly mo­men­tum-driven higher prices of Ger­man bunds and U.S. Trea­suries that neg­a­tive yields have pro­duced, he said.

"A 30-year Trea­sury at 2.5 per­cent can wipe out your an­nual in­come in one day with a 10 ba­sis point in­crease," Gross said.

He said the se­cret, in a neg­a­tive in­ter­est-rate world that poses ex­tra­or­di­nary du­ra­tion risk for AAA sov­er­eign bonds, is to keep bond ma­tu­ri­ties short and bor­row at those at­trac­tive yields in a mildly lev­ered form that pro­vides a yield and ex­pected re­turn of 5-6 per­cent.

Gross said in­vestors should fo­cus on sec­tors that are less volatile and less af­fected by the evolv­ing changes of the mon­e­tary sys­tem, such as closed-end funds at deep dis­counts, or highly cer­tain ac­qui­si­tion ar­bi­trage stocks. All told, Gross said: "Cen­tral bankers seem ever in­tent on go­ing lower, ig­no­rant, in my view, of the harm be­ing done to a clas­si­cal eco­nomic model that has driven pros­per­ity, un­til it reached a neg­a­tive in­ter­est rate dead end and could drive no more."

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