Last Friday, Bill Gross, the former "Bond King" who recently came out of retirement, expressed in an interview that those optimistic about the future trends of the stock and bond markets are mistaken due to clear overvaluation in both sectors. Gross believes that the inflation rate will be around 3% in the future, and an increasing number of experts agree that the Federal Reserve will eventually raise the inflation target from 2% to 3%.
The former co-founder of PIMCO stated that the fair value of the 10-year U.S. Treasury yield should be around 4.5%, while its current level is about 4.16%. Historically, the yield on 10-year U.S. Treasury bonds has been around 135 basis points higher than the Federal Reserve's policy rate. Even though the inverted yield curve from 2005 to 2010 did not follow historical precedent, considering the historical relationship and current market conditions, the current yield on the 10-year U.S. Treasury bond remains too low.
Gross also believes that the soaring U.S. government fiscal deficit will increase the supply pressure in the bond market and push up the yields of government bonds of all maturities, especially the 10-year Treasury yield.
Gross delved into the importance of high interest rates as a sign of a healthy economy and the impact of real yields on economic growth and inflation control. He believes that due to the rise in real interest rates and the impact of past fiscal plans, the prospects for consumption, employment, and overall economic growth may slow down, though a recession or hard landing is still far off.
Discussing the stock market, Gross reiterated the view of Mike Wilson, Chief Investment Officer of Morgan Stanley, stating that the Equity Risk Premium (ERP) - the difference between earnings yield and bond yield - is at a 20-year low, indicating that the current stock market is overpriced.
Gross also mentioned that the market environment is changing, having sold off regional bank stocks held after a recent rebound. Looking ahead, the former Bond King believes that the assets with the "best value" are energy pipeline partnerships, as they offer higher yields and deferred tax returns.
