“Bond King” Bill Gross Prediction for 2018: The Bear Bond Market Is Here

China and Bill Gross Warn That the Bear Market Is Approaching

The loss of China as an investor is something the United States should start worrying about. Far from how some Trump voters may absorb this possibility, it could spell significant market trouble for them and many other Americans. The alarm comes from Bill Gross, who has made a reputation for knowing when to buy or sell bonds. They don’t call him the “Bond King” because he has a large collection of 007 DVDs.

In a recent interview, Gross said he’s making a bearish bet on the bond market through the Global Unconstrained Bond Fund, through Janus Henderson, the firm he manages. Gross expects U.S. Treasuries to drop in value because yields are rising quickly—yields increase as Treasuries’ prices fall. (Source: “‘Bond king’ Bill Gross has ‘gone short’ on bonds,” Financial Times, January 10, 2018.)

Why Is China Losing Confidence in the U.S.?

What’s driving the loss of confidence in the U.S. that a drop in Treasury values implies? Bond King Bill Gross has no doubt: it’s all because of China, which has been selling off some of its U.S. assets. Gross noted that high yield bonds—aka “junk bonds”—have become especially risky despite them having become popular since the 2008 financial crisis. This marks an important risk, given the potential for U.S. China sanctions over trade or North Korea.

Bonds, their market, and yields are one of the barometers of overall stock market sentiment. If the Chinese have started to pull out from U.S. Treasuries in a noticeable manner—enough to trouble Bill Gross—it’s a sign that an equities bear market may be around the proverbial corner. Because of the higher yields, portfolio managers could start shifting their clients’ savings from stocks to bonds/treasuries.

This could happen faster than even Gross—or Jeffrey Gundlach, for that matter—might think.

Stock values are at absolute highs, but nobody can offer a decent explanation for these record valuations. Indeed, there is a perception that the stock rally could end abruptly amid a series of lingering risks from geopolitics and from too much exuberance—perhaps driven by the economic growth that Trump’s tax cuts have promoted.

Certainly, corporate earnings, that traditional and perhaps outdated harbinger of stock valuations, have been rather flat for the past four years or so. The small corrections also point to the fact that when sentiment turns bearish, it will do so in a spectacularly bad “herd” manner, producing a major market crash.

Bearish Sentiment Is Growing Everywhere

That’s what Janus Fund Manager Bill Gross and China are worried about. Gross said that he’s bearish on U.S. Treasuries, U.K. gilts, and German Bunds. (Source: “Pimco could add U.S. Treasuries if market weakens further: Ivascyn,” Reuters, January 10, 2018.)

The reason investors should worry is the translation of all this. Whether you understand the bond market or not, there are worrying signs. Institutional investors have begun to sing from the songbook of those who worry the markets are no longer making sense. China, being one of the main buyers of U.S. debt, has sent the first shockwaves, noting it finds the U.S. market unattractive.

Central banks, from the Federal Reserve to the European Central Bank or the Bank of Japan, share China’s concerns. Yields are increasing in many major economies, from Spain to Germany. China is merely the trigger. And there’s little that can be done. President Trump has put much pressure on Beijing.

In turn, the Chinese want to reduce their debt levels. This combination—that is, China’s perception of U.S. hostility and its own economic needs—explains the deeply nationalistic nature of China’s motivation for selling off U.S. debt. In other words, they won’t easily back down.

Don’t Ignore the Impact From Central Banks’ Policies

Moreover, there are concerns over how the advanced economies will absorb the impact of rising interest rates, as central banks might terminate quantitative easing (QE) policies. QE has lasted longer than many had expected. The low interest rates were needed to boost economic activity in countries that endured difficult conditions after the 2008 sub-prime crash.

The problem is that once more investors catch on to the fact that bond markets are falling, favoring yields, it will be impossible to stop money managers from making their move. The effect of the U.S. tax bill will be to limit its ability to adjust to inflation. Every point of higher interest means much higher debt payments. Lower taxes make servicing the current debt payments more problematic already.

Finally, consider the inevitable demise of the retail industry. It’s no mystery that the rise and increasing dominance of Amazon.com, Inc. (NASDAQ:AMZN)—and the online units of many retail chains—has caused a hemorrhage of jobs in the traditional retail industry. There’s also the drive toward further automation and artificial intelligence.

Thus, in the mid and long terms, there are substantial systemic risks to the overall health of the American economy. We have tested the limits of the bull market since 2009. With every new record high, the chances for a massive and heavier fall increase.