Bill Gross, the widely followed investor who runs the Janus Global Unconstrained Bond Fund, said on Thursday that investors should not be tempted into purchasing beaten-down bank stocks against the backdrop of interest rates potentially turning negative.
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In his latest Investment Outlook report, Gross said negative yields threaten bank profit margins as yield curves flatten worldwide and bank net interest rate margins narrow.
"The recent collapse in worldwide bank stock prices can be explained not so much by potential defaults in the energy/commodity complex, as by investor recognition that banks are now not only being more tightly regulated, but that future Return On Equity's will be much akin to a utility stock."
Gross warned investors: "Banking/finance seems to be either a screaming sector ready to be bought or a permanently damaged victim of write-offs, tighter regulation and significantly lower future margins. I'll vote for the latter."
Gross said investors should not reach for the "tantalizing apple of high yield or the low price/book ratio of bank stocks." Those prices are where they are because of low/negative interest rates, Gross said.
Additionally, investors should not reach for the seemingly momentum-driven higher prices of German bunds and U.S. Treasuries that negative yields have produced, Gross said.
"A 30-year Treasury at 2.5 percent can wipe out your annual income in one day with a 10 basis point increase," Gross said.
"The secret in a negative interest rate world that poses extraordinary duration risk for AAA sovereign bonds is to No 1, keep bond maturities short and No 2 borrow at those attractive yields in a mildly levered form that provides a yield and expected return of 5-6 percent."
Gross said the advice about borrowing at low yields obviously has to be matched with investments that are less volatile and least affected by the evolving changes of the monetary system.
"But it can be done," he said. "Closed end funds at deep discounts, highly certain acquisition arbitrage stocks, as well as volatility sales at tails are general examples."
(Reporting By Jennifer Ablan; Editing by Chizu Nomiyama)