Update (29/11): a version of this article with a video of the full interview can be viewed here.
Here are our notes [mostly paraphrasing vs. direct quotes] taken during the recent interview of Bill Gross and Larry Fink at the UCLA Anderson School of Business by Bloomberg’s Eric Schatzker. Broadcast earlier tonight on Bloomberg TV’s “Heavy Hitters.” Will let you know when we get a link to a more substantial video replay.
Gross: Not a 2008 Minsky moment, but we are still de-levering. We had a lack of aggregate demand and levered up to sustain consumption. Technology & demographics are structural problems in developed countries that can’t be addressed by fiscal or monetary policy. Peaking of consumption in the next 5 to 10 years.
Fink: Agree, but much of this is already priced into the market. Owning a bond eats away on returns; just not going to achieve your expected returns with that.
Gross: The ECB is of a different mindset vs. the U.S. Even though Trichet is French and Draghi is Italian, the ECB is dominated by a German mentality.
Fink: There are now governments working towards balanced budget amendments. Unions in Spain are talking about restructuring. Finally countries like Spain and Italy are responding to global capital markets. But stakes are very large and the outcome can be black or white. In the end, Germany doesn’t want to see the Euro disappear. It would probably mean bankruptcy for every financial institution and major company because liabilities are in Euros.
How does Europe rank in U.S. threats?
Gross: At the top. The U.S. has been flying under the radar despite a present value of $60tn in future liabilities. But with the reserve currency and growth at 2.0% to 2.5%, compared to recession prospects elsewhere, investors still buy the U.S. over Euroland.
If you were to look to America like a stock, would you buy it?
Fink: Short run yes. Long run, no.
Gross: The U.S. is not a junk bond, but is still highly levered. Ultimately it’s a question of whether there’s inflation/reflation. If you were a saver/investor, would an atmosphere of 1-2% real growth entice you to invest? He’d say no.
Gross: The failure of policy is the emphasis of benefits going to consumption instead of investment. We have also spent the past few decades making paper, not things.
Fink: We need to be a manufacturer again. We need to invest in infrastructure. Convert Fannie Freddie properties to rental [Bill Ackman made a similar suggestion at the Harmonie Club the other month; full version of that at bottom]. Agree with Bill’s conclusions, but less bearish. Think mentality of U.S. is unique: start-ups, intellectual capital of software development, still the innovator of medical research.
Gross: Yes, we have Facebook, Google, and Apple, which are significant in terms of profit creation, but they are not significant in job creation.
Fink: Many of the jobs lost were in construction. Our problem wasn’t in ’08 or ’09, but in the building during ’03 to ’07. Those were the seeds of the destruction. But would argue we are 2-3 years away from stability. 1.25mn homes are needed for replacement, immigration, and family formation. Of course we still need to work on our immigration policy and let foreign graduate students stay here to start companies and create jobs. Sees rebound by 2014; the next president will be benefiting from the stabilization of housing.
Who would they vote for?
Fink: People being unhappy with the government is not an unusual for a democracy. Actually happy with Occupy Wall Street because for the first time in 3 years you have “fringe element symmetry.” Tea Party said many good things, shaped ’10 elections, but Fink was surprised there was no Tea Party equivalent on the left at the time. Washington and the financial community really did let down a lot of people. There was huge confidence that Washington would protect people through policy. And finance effectuates governmental policy – they’re the ones that buy Fannie, Freddie.
Gross: Share sympathy with labor vs. capital. For 20-30 years, capital has been winning. Compensation has decreased from 69% to 62% of GDP while profits have increased from 8% to 13% or 14% of GDP. How could one not sympathize with their predicament? You can disagree with solution, but to not have sympathy with Main Street would be to have blinders.
Would vote for neither candidate in this election. Is a registered Republican but voted for Obama. Was there change he could believe in? There wasn’t. Washington is dominated by K Street. Jeffrey Sachs has suggested a third party. It might resemble the movement like Ross Perot’s; it might not. But Republicans and Democrats are like a two-faced one-sided Jack in a deck of cards.
If you were on the supercommittee, which sacred cows would you kill?
Fink: Entitlements are on a crash course. We have increased life expectancy but are not saving to compensate. Entitlements are going to have to be extended at a later age. Taxation will have to increase. Privately, politicians acknowledge this, but will never say it in public. Problem is the election cycle is so short that politicians are not standing up as leaders. Every state solution has been to tell retiring people that they’ll keep the benefits the same, but all the young people will bear the cost. As we continue to put more and more of the burden on young people, Fink would not be surprised by a large number of protesting by young people. To create dynamic economy, can’t place the entire burden on the young.
What do you do with your money?
Gross: Developed world has entered what Rogoff & Reinhart would call a period of financial repression. Low investment returns and negative real interest rates. We have three options: we can default, inflate, or financially repress the savers. Low interest rates or negative interest rates set the tone for the stock market as well. Without high levels of growth, the pricing of financial assets will not allow investors to achieve the returns they have had for 30 years. We are not in an 8-9% world, but in a 4-5% world.
Is now an appropriate time to be taking risk?
Fink: Bernanke is saying get out of bonds. Doesn’t necessarily think you have to be in a 4-5% world; you can find opportunities at 7%. Going to have to throw out the traditional mix of bonds and equities though. You need dividend-based equities to achieve returns. But it means minimizing allocation of bonds; if you’re bond-heavy, you’ll end up with 4 or 5% returns.
Investors have two choices: double their contribution to retirement and then a high allocation to bonds would be appropriate. If they have the fortitude to look beyond the next few years and the capability to invest for 10-year cycles, then equities will pay off. But they have to be multinational. Don’t be so U.S. dependent. Don’t be China dependent. Beauty of corporations is their ability to be global. P/E ratios are pricing in fear. Today, a larger than normal to equity and dividend securities will pay off over long cycle.
Gross: Can developed economies reflate? Can we produce an old economy of 4 to 5% nominal growth? Not a slam dunk. Look at Japan.
Fink: But Japan did not do what Bernanke did.
Gross: But that doesn’t mean policy makers will be correct in everything. Look at the policy errors in the depression. If the policy makers cannot reflate, then higher quality and safer investments are better. If they can, then equities are the better choice.
How are you investing your money?
Gross: A barbell/mix of both. On the quality side, not investing in treasuries [audience laughs], but investing munis. Then on other side, investing in global growth companies with dividends. Companies like PG, JNJ, and KO, with 3-4% dividend yields and good growth prospects.
Fink: Yes, but don’t need to sign it.
Gross: Haven’t signed pledge but been giving for years. Would prefer the question to not have come up. Thinks there should be a place for giving without public recognition.
Fink: [aside] How Warren invests epitomizes in long cycle investing. He doesn’t care about quarterly earnings. Returns are strong because his focus is equities over the long cycle. Was talking with Warren Buffett one day when the market was down significantly and in the middle of the conversation, he got up two or three times to buy stocks. We envy and admire Warren Buffett, but most of us don’t have the inclination to invest like him.
Gross’s Question: Investment management being a non-levered business has left them in not as dire a situation. Where do you see the business 5 to 10 yrs? How will we adjust to a de-levering environment?
Fink: When he started, Wall Street was a cottage industry, with $50mn–$60mn firms. The money holders, like the big insurance companies, were the ones who controlled the business. Thinks we’re going back to future as investors have more control again. Most people are too young to remember how small Wall Street was back in the day. Believe we are going into a decade where money holders will have significant responsibility; more than we’ve had in our lifetimes.
Blackrock is also the largest investor in 2,400 companies. Think about what that means with proxies. Capital will be king. Responsive businesses will grow and the importance of their actions will increase. Voice in policy changes will be more significant.
Fink’s Question: How is it here in Newport Beach?
Gross: It’s a great life
Fink: So I’m the dumb one
Gross: [jokes] Who can argue with that?
In the past, it would have been heresy to think you could run a successful money management business from the west coast. But globalization negates the need to be in New York, London, Tokyo, or even Beijing. Get up at 4:00 a.m., home at 5:30 p.m. when there’s still some California sun.
What would do you think is best of Blackrock that PIMCO doesn’t have?
Gross: He would take the ETF franchise. Doesn’t know if he would pay for it, but would gladly take it. ETFs, which PIMCO haven’t done as well, would be an area he’d emphasize. Would also welcome the equity franchise. Blackrock is better balanced not just in terms of the domestic/global mix, but also the bond/equity mix.
What would do you think is best of PIMCO that Blackrock doesn’t have?
Fink: Has been working with PIMCO for years. Bill was Larry’s biggest client when Larry was at First Boston. PIMCO has been one of the most intellectually innovative firms. The quest for ideas and process for investing has separated PIMCO from any other firm in the business. There is a strong team and there has been a consistency in the organization. You see so many stars who are just incredible for 5 years. But Bill has been doing this since ’71.
What’s your motivation? Fame? Money? Power?
Gross: Fame [joke]. Just becoming respected in the practice of allocating capital. Not so much becoming a famous five-year flash in the pan, but becoming respected.
Fink: Fear and paranoia [joke]. Just respect. Just wants to work hard and be respected when it’s all done. Everything else is secondary to building a career or firm. That’s more important than fame, money, or power.
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