Will Bill Gross Be Right This Time?

It has been a while since legendary bond fund manager Bill Gross has been in the news. I last wrote about Gross in 2015 when he proclaimed an end to the bull market super-cycle for stocks and bonds that began in the 1980s.

As I noted then, that wasn’t the first time Gross called a top for the stock market. And as with the previous times, he turned out to be wrong. Since then, the SPDR S&P 500 ETF Trust (SPY) has more than doubled in value.

What worried Gross seven years ago was an end to the massive quantitative easing (QE) program initiated by the Federal Reserve after the stock market crash in 2008/2009. He reasoned that interest rates would soar once the Fed stopped buying bonds, thereby triggering a recession that would sink the stock market.

However, interest rates rose only slightly in the years following the cessation of QE. In 2018, the yield on the 10-year Treasury note rose above 3% before reversing direction and falling below 2% the following year.

Two years ago, the Fed once again implemented QE to prevent the economy from collapsing in the wake of the coronavirus pandemic. Rising inflation and low unemployment brought that round of QE to an end this month.

Now, Gross is concerned that the Fed could “crack the economy” if it raises interest rates too fast. That comment followed this month’s first rate hike by the Fed since 2018.

Gross is not alone in that concern. Many economists argue that we have become addicted to low interest rates. When interest rates rise, so does the cost of borrowing money to purchase homes, automobiles, and anything that can be purchased with a credit card.

A Critical Difference

As I asked seven years ago, is Bill Gross right this time? And if so, what does that portend for investors in the years (and decades) to come?

There is a critical difference between now and 2015. Back then, the Consumer Price Index (CPI) was growing at less than 1%. Last month, the trailing 12-month growth rate for CPI was nearly 8%.

The last time CPI rose above 5% was in 2008, just before the stock market crashed. For that reason, the Fed feels compelled to raise interest rates before soaring prices crack the economy.

That is why Fed Chair Jerome Powell stated last week that he “will adjust policy as needed in order to ensure a return to price stability with a strong job market.” His goal is to bring the annual growth rate of CPI back down to 2% while keeping the unemployment rate near 4%.

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If Powell can do that, the stock market should not crash later this year. For all we know, it may have bottomed out two weeks ago and is already in the early stages of recovering from its recent correction.

If that is the case then now would be a good time to buy into the iShares Russell 2000 ETF (IWM). This fund owns small-cap stocks that are more economically sensitive than bigger businesses with more substantial financial assets.

For that reason, IWM tends to overreact to reversals in market sentiment. When large-cap stocks as measured by SPY fell 6% during the first month of this year, IWM was down 10%.

The reverse can also be true. When confidence in the economy is high, small-cap stocks tend to appreciate at a higher rate than large-cap stocks.

On the Precipice

If you believe Bill Gross will be wrong again about the stock market, loading up on the small-cap stocks held by IWM could pay off big. In a good year such as 2019, this fund has returned better than 25%.

However, if Gross is correct and the economy cracks under the weight of higher interest rates, you may want to hold off on buying into this fund. Instead, leaving your money in cash until the Fed has inflation under control might be the better way to go.

As I explained last week, the global economy is on the precipice of a new economic paradigm. The financial conditions that made Bill Gross a bond market superstar are no longer in place.

To make money in the stock market going forward, you need to think outside the box. And few analysts are better at doing that than my colleague, Nathan Slaughter.

Nathan Slaughter is the chief investment strategist of Takeover Trader. As Nathan points out, corporations are flush with cash and they’re about to unleash a “feeding frenzy” of merger and acquisition activity. You can profit from the coming chaos on Wall Street, by following Nathan’s advice. Gain instant access to his insights, by clicking here now.