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Bill Gross Has Some Thoughts About the Market
The retired bond manager wades into the value versus growth debate.
Retired bond king Bill Gross is back to share his opinions about those other publicly traded securities: stocks.
Gross on Tuesday published a new investment outlook — his second since retiring from Janus Henderson Investors in early 2019. This time, the former fund manager had some thoughts on growth stocks and why they have done, in his words “so fabulously well.”
After a self-described “rant” about CNBC’s interviewees (“They kiss derriere,” Gross complained), the retired investor moved on to the stock market, focusing on explaining the performance of the “Fab Five,” a group of high-flying tech stocks including Amazon and Apple.
“Of course, there’s the reopening of much of global economies, and the hope for a vaccine, or if not, that Covid-19 will just fade away,” Gross wrote. “But there’s another likely explanation that centers on interest rates — real interest rates that have come down, down over recent years and are still reaching historic lows.”
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According to Gross, declines in interest rates — and associated declines in the real interest rates of inflation-protected Treasury bonds, or TIPS — have a much larger impact on growth stocks like Amazon and Apple than on value stocks. This is based on a formula called the Gordon Growth Model, which states that a company’s current stock price is equal to its dividends divided by a function of the rate of return minus the expected growth rate of future dividends.
As Gross explained, when real long-term interest rates fall, the calculation for dividends changes. “A drop of 150 to 200 basis points in real long-term interest rates, which has occurred in recent few years, can impact the price of Apple or Amazon by as much as 50 percent, everything else being equal, and they have,” he wrote. “The effect is much less for cyclical/value-oriented stocks because their expected growth rates generally decline as well.”
As evidence for the relevance of this formula, Gross cited Microsoft’s high correlation to TIPS. “When TIP goes up, Microsoft goes up,” he wrote. “When TIP goes down (real yields up), Microsoft goes down. (Not daily, but over a week or two weeks’ time.)”
At the time of writing, Gross added that real 10-year TIPS were trading at negative 75 basis points — “quickly approaching the linker yields of Germany and Japan, which are so low that the only buyers are governments and regulated pension funds.”
“The future price disparity of Microsoft, Apple, and Amazon relative to lesser growth but still high quality stocks like Coca Cola or Proctor & Gamble, is subject to an ongoing decline in real rates, which to my mind, have seen their best days,” Gross continued. “Value stocks, versus growth stocks, should be an investor’s preference in the near-term future.”
His stock picks: gas and oil company Enterprise Products Partners, tobacco producer Altria Group, tech firm IBM, and pharmaceutical company AbbVie.
“No guarantees!” he added.