The famed bond market guru Bill Gross recently criticized fellow bond investors for failing to grasp basic mathematics. Gross cautioned that too many investors try to make a profit out of bonds with negative yields, but their lack of knowledge in basic mathematics and economics could lead to their downfall.
In his opinion a professional bond investor that wants success needs to be an economist, mathematician, and horse trader, all three at once. But he goes on by saying that bond market players “are still thinking and managing assets at the grade-school level.”
Gross believes that the main reason for this situation is investors’ superficial understanding on how the paradoxical negative bond yields work. To make things clearer, he resorted to an ancient Greek paradox dubbed Zeno’s paradox.
According to the paradox, if a walker divides the distance he or she has to cross into infinitesimal fractions, mathematically he or she would never reach the finish line, though the sum of infinitesimals yields a finite result, i.e. the distance that person needs to walk.
But in the real world, people move in ‘full step integers’ rather than fractions, which is what bond investors fail to grasp.
In other words, Gross added a mathematical twist to the absurd dilemma of bond investors that need to sell their negative-yields bonds before maturity to make a profit. Their profit is exactly the difference between the initial negative yield and an even lower negative yield and so on ad infinitum.
Gross noted that in this game of musical chairs, bond investors try to convince themselves that they would never ‘reach the loss-certain finish line’ when the bonds mature.
The bond investor argued that if an investor losses money in this game, a stock investor would also lose money or make less profit than historical expectations. Economists know that central banks purposely keep rates low to steer investors into investing in assets with positive yields, so they can kick-start the entire economy.
But on the real market, Gross believes, that strategy doesn’t work as players act erratically. This is why central banks are now on a race against time to restart the economy’s engines before investors start hemorrhaging money, Gross added.
He finished by underscoring that negative rates lead to capital losses not gains.
“Investors cannot make money when money yields nothing,”
He concluded that central banks can normalize their rates only when inflation or real economic growth reaches the levels that allow them to do so.
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