Gross Proves Summers Wrong as Selloff Shows ‘New Normal’ Is Real

By Sree Vidya Bhaktavatsalam
Aug. 10 (Bloomberg) -- Bill Gross was right after all.
Former White House economic adviser Lawrence Summers and
Christina Romer, the former chairman of the U.S. Council of
Economic Advisers, were among critics who challenged a view
promoted by Gross’s Pacific Investment Management Co. that the
U.S. economy may be headed for a long period of below-average
growth and high unemployment, a scenario known as “new
normal.” Money manager Kenneth Fisher called the concept
“idiotic.”
Now Gross and co-chief investment officer Mohamed El-Erian,
who coined the term more than two years ago, have been
vindicated by the U.S. Federal Reserve, which said yesterday
that the economic recovery is “considerably slower” than
anticipated, following the biggest stock market loss since
December 2008. BlackRock Inc. co-founder Laurence D. Fink, who
in January said he didn’t believe in the “new normal,” is
forecasting growth of 1 percent to 2 percent for much of the
decade.
“A lot of the new normal characteristics have played
out,” El-Erian, chief executive officer of Newport Beach,
California-based Pimco, said in an interview. “Some people
confused new normal with fatalism, but the intention was the
opposite. There was the hope that policy makers would recognize
that there are structural responses they needed to embark on.”

‘Japanese-Like Growth’

The Federal Reserve yesterday pledged for the first time to
keep its benchmark interest rate at a record low at least
through mid-2013 to revive the flagging U.S. recovery. Chairman
Ben S. Bernanke and his colleagues acted after reports showed
the economy was slowing and an unprecedented downgrade by
Standard & Poor’s to the U.S. credit rating triggered a stock
market rout that wiped out $1 trillion in the first trading
session after the cut.
“It’s pretty amazing that the Fed will be exceptionally
low until 2013,” said Jason Rogan, director of U.S. government
trading at Guggenheim Partners LLC, a New York-based brokerage
for institutional investors. “They are telling you that we are
in a stage of Japanese-like growth.”
Pimco outlined the “new normal” scenario at its annual
Secular Forum in May 2009 that set investment guidelines for the
firm for the next three to five years. The forecast predicted
that, following the market collapse in 2008, the U.S. economy
would grow at a below-average pace for the next several years as
growth in the developed markets slows, unemployment stays
elevated and the “heavy hand of government” would be evident
in the markets.

Quantitative Easing

Unprecedented asset purchases by the Fed helped revive the
economy and financial markets. U.S. stocks doubled from their
low in March 2009 to their high in April earlier this year.
Bill Miller, the manager famed for beating the Standard &
Poor’s 500 Index for a record 15 years through 2005, rejected
the idea of a “new normal” in 2009, saying that the odds may
not favor a prolonged period of slow growth.
Summers, the former White House economic adviser, said in
2009 he would be “very reluctant to accept the idea” of an
extended period of slow growth for the U.S. economy. Romer has
said she found the “fatalism” of the idea that unemployment
would remain elevated because of structural issues
“distressing.”
Summers wasn’t immediately available for comment, according
to spokeswoman Victoria Groves. Romer didn’t return a call
seeking comment.

‘Three-Plus Percent’

As the economy strengthened, the criticism grew louder. In
April, Romer said that the jobless rate “is not the new
normal.” BlackRock’s Fink said during a conference call with
investors and analysts in January that he never shared Pimco’s
view on the post-crisis economy.
“We never believed in the ‘new normal,’ ” Fink said then.
“We were always talking about a U.S. economy growing three-plus
percent.”
At the fixed-income unit of BlackRock, investment chief
Rick Rieder had been less optimistic, telling clients since at
least May 2010 that economic growth in the U.S. will be held
back by “structural” factors such as problems in the labor
market and the debt problems in Europe.
“We think there will be growth in the range of 1 to 2
percent,” Rieder, chief investment officer for fundamental
fixed income at BlackRock, said in an interview yesterday. Fink
used the same numbers in an interview with Bloomberg
Television’s Erik Schatzker in June, adding growth will remain
“modest” for the next 10 years.
Rieder oversees more than $600 billion for New York-based
BlackRock, which is the world’s largest asset manager with $3.7
trillion. Fink, who co-founded BlackRock in 1988, is chief
executive officer of the firm. While he oversees the asset-
management firm, investment decisions are left to individual
portfolio managers.

‘People Are Pessimistic’

Fisher said that Pimco and others are choosing to ignore
the positives in the market, while focusing on unemployment and
consumer spending, which are “late lagging indicators.” While
he hasn’t changed his view on the “new normal,” it will be
hard to make investors change their minds, said Fisher, chief
executive officer of Fisher Investments Inc. in Woodside,
California, which runs $44 billion in assets.
“People are pessimistic in the aftermath of a bear market,
so I expect ‘new normal’ to stay popular,” he said in an
interview. “I don’t expect it to go away anytime soon.”
Gross domestic product expanded at a 1.3 percent annual
pace in the second quarter, less than forecast by economists, a
July 29 government report showed. The economy almost stalled in
the prior quarter, growing at a 0.4 percent pace, the weakest
three-month period since the recovery began in mid-2009.
Hiring has slowed as employers lost confidence in the
recovery. Average monthly payroll gains fell to 72,000 in the
three months through July, from 215,000 in the prior three
months. The jobless rate fell to 9.1 percent in July from 9.2
percent in June as Americans gave up looking for work.

Missing the Rally

The Fed said yesterday it expects a “somewhat slower pace
of recovery over coming quarters,” adding that “downside risks
to the economic outlook have increased.” The Fed also said
there has been “a deterioration in overall labor-market
conditions in recent months” and household spending has
“flattened out.”
Gross hasn’t always been right about market calls. Earlier
this year, he dumped U.S. Treasuries from his $245 billion Pimco
Total Return Fund, only to miss a rally as investors fled to
safer assets amid market volatility and the sovereign debt
crisis in Europe. His fund has advanced 3.6 percent this year,
lagging behind 66 percent of peers, Bloomberg data show.
Earlier this month, Pimco cut its forecast for U.S.
economic growth from a range of 2 to 3 percent to a range of 1
percent to 2 percent.
El-Erian said he also “underestimated” how far the
Federal Reserve would go to stimulate the markets and the
economy by embarking on a second round of asset purchases using
a technique called quantitative easing.
“QE2 was a failed attempt to use the balance sheet of the
Federal Reserve to set the U.S. economy on a path of growth,”
El-Erian said in the interview. “We saw a short-term boost to
growth which has now petered out.”