Did Bill Gross Identify The Relative Value Play Of A Generation?
In a recent blog post, Bill Gross suspects the entire right half of his brain is missing. No, he’s not talking about a counter-trend trade in the U.S. dollar being the trade of the year or that brain freeze when he correctly called the bund trade but failed to execute. He’s talking about the hysteria – and bidding war – taking place in the high end art market.
In a financial world built on quantitative easing, high art prices and low interest rates abound
Noticing that Christie's landed $1 billion in art sales in the month of May, Bill Gross let his left brain, the mathematical, logical side, conduct the analysis. He observes that investors with few options might be choosing to invest in what they can see on a wall rather than a portfolio statement. It all ties together, however, as one factor is driving what he says is a “prime example of opportunities hatched by the excess of global monetary policy – zero based policy rates and tag team match quantitative easing programs which continue to encourage malinvestment in financial assets as opposed to the real economy.”
After humorously chiding himself for not executing on the German Bund market “short of a lifetime,” saying the trade was “well timed but not necessarily well executed,” Bill Gross identified a different type of trade. Rather than study a momentum play that requires price persistence to propel success, the man credited with having one of the more successful, if not sophisticated derivatives strategies in the history of the mathematically based industry, now sees a relative value investing opportunity. Price divergence has occurred, the question is when will the forces of mean reversion work their magic?
Bill Gross identifies relative value trade of a lifetime in QE-driven, stimulus-drunk world
As the U.S. is exhibiting an itchy trigger finger to raise interest rates – Bill Gross mentions sometime “late in 2015” – he notes 10 year Treasuries are still trading at nearly a 175 basis point premium to 10 year Bunds. Like any good relative value trader, the first thing he does is consider the historical correlations, and here he notes that the historical long term average of this price relationship is near just 25 basis. “A purchase of Treasuries and a sale of Bunds allows for not only a potential capital gain if the spread narrows, but a yield pickup while the Rip Van Winkle investor potentially waits for a probable outcome.”
While he doesn’t mention it, that “probable outcome” is the bund short he has been advocating, a trade he initially missed. In advocating this relative value trade, Gross is actually going with statistics. Rather than say a counter trend trade is the “trade of the year” – a counter-trend trade seldom eclipses a valid trend in terms of magnitude or duration – Bill Gross may have mentioned what could be one of the top relative value trades. While this trade is likely to take more than a year to play out – and the timing on the U.S. Treasury leg might be best optimized at a later date – the relative value spread Bill Gross identified is clearly on par to be considered in historic terms. While it might not be the trade of the year due to time horizon considerations – it’s hard to predict when the mean reversion might occur – but one might conclude it might be one of the top trades of the next two to three years.
Did Gross identify the trade of a generation? And is it a relative value play?
And it is here that Bill Gross has stumbled upon strong footing when declaring the “trade of the year.”
Absolute momentum plays are often the most difficult to correctly call – win percentage is statistically lower in managed futures algorithmic studies – but the win size of these strategies is where success is statistically found. It is the relative value play that has caught Bill Gross’s eye.
An explorer looking for these answers, however, should not necessarily be setting sail to find absolute values, but relative values. The “relative” narrows the universe significantly under the assumption that “relative” growth rates in the developed world and “relative” new neutrals should be more amenable to mean reversion then absolute values.
The world is a major relative value play. While Bill Gross considers the financial implications, we have a QE relative value play with U.S. Federal Reserve chief Janet Yellen on one end of the scale and a ringmaster with a much more difficult job on the other end of the scale. Buy Yellen and sell Draghi, the relative value probability tables seem to be saying, and this might not just be the trade of the next few years, but perhaps the trade of a generation.
Mario Draghi’s recently announced acceleration of May / June purchases based on Euroland’s seasonal summer siesta in August is just one example that can make an unattractive sovereign (Germany) even more unattractive in the short run. But even in this modern era of malinvestment in financial assets, investors should want to choose the least overvalued asset to hold, and the most overvalued asset to sell.
It's easy to understand Bill Gross based on his words, and his logic appears solid and insightful. One wonders if his trade actions will match the talk this time?
Read the full blog post here.
Disclosure: None.