Stocks

Bloomberg News

In the new normal, a world of excessive leverage and slower growth, a neutral interest-rate policy will by necessity produce lower rates than in previous business cycles, Pimcos Bill Gross wrote in his monthly commentary. and understanding that is the key for investors of all asset classes.

If future cash returns are 2% (our belief) instead of 4%, then other assets such as stocks and real estate must be assumed to be more fairly priced as well, he wrote. Current fears of asset bubbles would be unfounded. Lower neutral rates will lower the odds of asset bubbles, but it will also lead to lower overall returns across asset classes, he said.

Before he gets there, as he always does, Mr. Gross leads us on a breezy rumination on an apparently unrelated topic. This time its sneezing. Theres nothing like a good sneeze, he writes, and explains how back in the day, way, way back in the day, people would take snuff to force out a sneeze. The release of all that built-up pressure is a welcome rush, he explains, even if it does carry with it a couple hundred thousand possible germs.

The two sneezes that the markets have to be concerned with, back in the present day, are from the U.S. and China. The old saying goes that when the U.S. economy sneezes, the world catches cold. That still seems to be true enough, although Chinese influenza is gaining in importance, he wrote. The world saw what happened when the U.S. got a really, really bad cold in 2008. How to thread the needle today, keeping rates more or less neutral, but not too high to make debt servicing onerous, is a real trick. In a global economy with as much debt as the one we have today, its important to realize that the price of money and the servicing cost of that leverage are critical for a healthy economy.

What this likely means, he concludes, is a lower neutral rate than weve seen in the past. At Pimco, we believe that this focus on the future “neutral” policy rate is the critical key to unlocking value in all asset markets, he wrote. In a nutshell, he thinks a neutral fed funds rate may be closer to 2% than 4%. Understanding this would give a bond investor the key to the kingdom, he writes, but even holding that key comes at price, the price being lower returns across assets classes.

So you say you need more? Join the club. Most pensions funds, he notes, assume total returns somewhere around 7-8%. That wont happen with a 2% neutral policy rate. This will push investors into riskier assets.

Bring a handkerchief in any case.