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Bill Gross' Departure From PIMCO. Yes, You Could See It Coming

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Chronicling the travails of the most renowned fixed income investor of all time.

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There will be a lot of news stories today suggesting shock at Bill Gross' departure from PIMCO.

As a socionomist and a researcher in confidence-driven decision making, I was not at all surprised.  In fact, I have been expecting significant trouble at PIMCO as well as other fixed income asset managers for a long time.

The source of my concerns regarding PIMCO were solely a function of the overconfidence which I saw exhibited by that firm's leadership team as well other fixed income investors.  From my research I knew that the collapse in confidence which follows an extreme peak in confidence always generates scrutiny, tension and hardship.

To see why I saw trouble ahead for PIMCO going back to as far as July 2012, here is what I was sharing with my clients in real time:


July 12, 2012

How Low Can You Go? - Yesterday, the FT offered this thought, "The US borrowed for 10 years at the lowest rate ever in Wednesday's auction, (technically a reopening of an existing bond)...investors who were able to submit direct bids got their hands on a huge - record - amount of the total, around 45 per cent. The scale of demand at the auction suggests investors expect US interest rates to remain low for several years."

I realize that I am a very lonely with my belief that Treasury yields have bottomed, but whenever I see words like "record", clear investor extrapolation and phrases like "to remain low for several years" the hair on the back of my neck goes up.

At tops and bottoms in the market we believe that current conditions are permanent and with regards to the US Treasury market this feels like one of those moments.

August 30, 2013

What remains less obvious, though, is whether last Friday's peak in US interest rates is meaningful.  Yes, rates fell earlier this week alongside the "risk out" emerging markets trade, but I didn't sense the kind of media frenzy on higher rates I was hoping for.  Even more, I am troubled by comments I heard this week that there is a staggering amount of "shadow inventory" still awaiting sale.  Much like my long-standing question regarding GLD - "What does one do with the second largest holding in gold when sentiment turns?" - I am deeply concerned about the challenges that fixed-income giants like PIMCO and Blackrock now face in trying to downsize their portfolios as more and more investors conclude that THE bottom in rates is in. 

Needless to say, given the asymmetry of risk I see, I would use lower interest rates as an opportunity to further reduce fixed income exposure.

PS - There were two items regarding PIMCO which drew my attention this week that I think all fixed income investors should consider, given that firm's significance to the overall liquidity of debt markets today. 

First, in an aptly timed op-ed on Barrons.com on inflection points in the bond market, PIMCO COO Douglas Hodge offered, "As rates reset at higher levels, yields will likely increase, enhancing the opportunity for bonds to provide even more attractive return and income."
While in the very short run this may be the case, history shows that once a bubble is popped and sentiment reverses, lower prices are met with lower, not higher demand.  To the extent that PIMCO - and likely all other large bond investors - are assuming that higher demand will arise when prices fall further, there are enormous opportunities for wide scale price gaps when those assumptions are proven to be false.  (By analogy, please consider what shifting sentiment has done to Apple stock over the past year.)

Second, yesterday's Wall Street Journal noted PIMCO's recent push into "riskier, more-complex products" aimed at retail investors.  As long-time readers know, "complexity" and "naïve/novice" participants are telltale signs of a peak in confidence.  Coupled with the near-saturation of Dr. El-Erian and Mr. Gross in the media, I am worried that the firm is displaying many indicators of overconfidence.
While overconfidence is worrisome in and of itself, attached to a firm managing $1.2 trillion in capital takes the concern to a whole new level.  Even on its best days, the fixed income market provides nowhere near the liquidity assumed by most investors.  A concurrent decline in confidence in both fixed income and the market's largest investor could create quite a cascade.

As I have offered before, the greatest threat to fixed income is not higher interest rates per se, but rather changes in investors' perceptions of the "safety, liquidity, low volatility and negative correlation with risk assets" assumed to exist today by holding fixed income in a portfolio.

As always, I don't wish for any of this, but sentiment matters.  What I see today for both PIMCO as a firm, and the fixed income market in general, gives me serious pause.

September 6, 2013

PS - As a follow up to my comments on PIMCO last week, I would highlight that this week Marketwatch columnist Paul Farrell dedicated an entire column to the differing views of the world offered by Bill Gross and Mohamed El-Erian, noting that they "sound like parents at war on a television sitcom. One an aggressive optimist. The other a pessimist who even calls himself a 'worrywart.'"

With PIMCO's assets under management down 14% from their peak, the fact that leadership divisions are now surfacing is a perfect confidence-driven fit.  Needless to say, if fixed income confidence falls further what is today a "war on a television sitcom" could resemble the War of The Roses.  While not wishing it for PIMCO or its clients, the co-head leadership arrangement at PIMCO could have a very limited life.

And to that point, this Google Trends chart of searches for "Bill Gross" is not encouraging.



January 24, 2014

A House Divided - In my September 6th Commentary I wrote that I believed a major top in US Treasuries yields was occurring.  In support of my conclusion, I noted the following:

[This week] Marketwatch columnist Paul Farrell dedicated an entire column to the differing views of the world offered by Bill Gross and Mohamed El-Erian, noting that they "sound like parents at war on a television sitcom. One an aggressive optimist. The other a pessimist who even calls himself a 'worrywart.'"

With PIMCO's assets under management down 14% from their peak, the fact that leadership divisions are now surfacing is a perfect confidence-driven fit.  Needless to say, if fixed income confidence falls further what is today a "war on a television sitcom" could resemble the War of The Roses.  While not wishing it for PIMCO or its clients, the co-head leadership arrangement at PIMCO could have a very limited life.

This week we found out just how limited when CEO Mohamed El-Erian resigned from the firm.

Bottoms in confidence are repeatedly marked by acts of sacrifice.  Very weak confidence generates a sense of uncertainty so great that something must be done to eliminate it.  In the corporate world, bottom-marking acts of sacrifice routinely include leadership changes, board revolts, troubled business line divestitures and major litigation settlements.  At the bottom, something or someone has to go.
With US Treasury yields reaching new highs at the end of 2013 (and bearish sentiment at an extreme, with EVERYONE calling for higher interest rates in the year ahead) the stage was set for a bottom in bond prices and a leadership change at PIMCO.  (And per Bill Gross, Dr. El-Erian's departure "had been in the offing for weeks" before it was announced on Wednesday.)

From my perspective, Dr. El-Erian's departure from PIMCO is a very useful lagging indicator of the significant bottom in bond prices at the beginning of the year; and, if anything, it suggests that the retracement in yields and the length of the bullish trend ahead may be even more significant than I thought three weeks ago.  Where I was thinking that we could see 10 year US Treasury yields as low as 2.25%, this week's news out of PIMCO suggests that we could test 2% before then heading higher.

February 28, 2014

Diana Ross - This week, Greg Zuckerman of the Wall Street Journal went inside the "Showdown Atop PIMCO" offering new insights on the tumultuous departure of Mohamed El-Erian from the money management.

What I found so interesting about Mr. Zuckerman's piece was the specific timing of the various events and how they tie to the 10 year US Treasury yield:



I offer this chart this week not for its gossipy interest, but because it highlights just how much confidence within PIMCO ties to interest rates.  As rates rose sharply over the past year, confidence plummeted with even the firm's most seasoned senior leaders displaying very "me, here, now" behaviors in which self-interest trumped all else.

But please appreciate that these actions happened within one of the world's largest and most highly respected asset management firms.  PIMCO is clearly one of the confidence oligarchs I discussed above.

For my thoughts on our current oligopoly in confidence see this past article.

Should equity markets begin a pronounced decline, we should expect similar behavior among the world's largest equity firms as well.
What remains unclear to me, however, is how tolerant the investors, particularly the institutional investors, of all of these firms will be to mounting management turmoil amidst a harsh market decline.

My concern is that given the enormity of each individual member of the confidence oligopoly, turmoil at one firm could dramatically impact prices for everyone as assets are liquidated for redemption.  As the chart makes clear above, PIMCO suspended "non-essential" trading in response to market price deterioration.  The same could happen among equity managers too.

Needless to say, if this then becomes an expected market practice, the pressure to exit fast and first will intensify.

March 14, 2014

In fixed income, the Treasury market continues to move as expected.  My target remains 2.00%-2.25% on the ten year.  And yet again, Bill Gross' news helped call the top in rates this week.  On Monday, in an interview with the Los Angeles Times, long-time PIMCO trustee, William Popejoy, took issue with Mr. Gross' $200 million annual compensation.

September 26, 2014

PS - The news this week that the SEC is looking at PIMCO's ETF pricing is to be expected.  Lower confidence brings more scrutiny.   As I offered last year, higher interest rates will bring significant changes to PIMCO and other fixed income managers.

Like the NFL (see below), not only is PIMCO an icon under siege, but they don't see it yet.  Many of their "don't ask, don't tell" standard operating practices will face scrutiny.  Most won't stand up to the light of day.

To be clear, I don't wish any of this anyone, but history offers example after example of how quickly we lose confidence in icons.  PIMCO faces extraordinary challenges ahead and with that so too will other fixed income asset managers. 

To be clear and to reiterate, I wish no one, no firm nor any investment class misfortunate.  What I saw beginning in 2012 were all of the telltales of overconfidence.  What we have witnessed, and I suspect will continue to witness based on the extraordinary peak in fixed income prices that has occurred, will be a severe and prolonged decline in confidence.  Bill Gross' departure from PIMCO is just the latest example of the impact.

Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
 
"Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the 'me, here, and now' behavioral tendencies of the post-crash world."  -Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation


Twitter: @Peter_Atwater
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