In his lat­est edi­tion of his monthly newslet­ter, Bill Gross waves good­bye to the “New Nor­mal” and adopts the “Paranormal”.

The fol­low­ing are a few excerpts from the report:

The New Nor­mal, pre­vi­ously believed to be bell-shaped and thin-tailed in its depic­tion of growth prob­a­bil­ity and finan­cial mar­ket out­comes, appears to be mor­ph­ing into a world of fat-tailed, almost bimodal outcomes.

A new dual­ity – credit and zero-bound inter­est rate risk – char­ac­ter­izes the finan­cial mar­kets of 2012, offer­ing the fat left-tailed pos­si­bil­ity of unfore­seen pol­icy delev­er­ing or the fat right-tailed pos­si­bil­ity of cen­tral bank infla­tion­ary expansion.

The crit­i­cal ques­tion of course is whether efforts by the ECB, BOE, and Fed will work. Can they rein­vig­o­rate ani­mal spir­its in the face of “credit” and “zero bound money” risk? We shall see. An investor how­ever should hedge his/her bets until the out­come becomes more obvious.

Bond Mar­kets

1. Dura­tions and aver­age matu­ri­ties should be at their max­i­mum per­mis­si­ble lim­its. Even if refla­tion is suc­cess­ful it will only be because the Fed and other cen­tral banks keep pol­icy rates low for an “extended period of time.” Finan­cial repres­sion depends on neg­a­tive real yields and until infla­tion moves higher for a period of at least sev­eral years, cen­tral banks will hiber­nate at the zero bound

2. The bulk of sov­er­eign bond hold­ings should be in the U.S. as long as Euroland credit implo­sion is pos­si­ble investors should grav­i­tate to the “clean­est dirty shirt” sov­er­eigns with the least encum­bered bal­ance sheets. Any­thing short of a 5-year matu­rity how­ever yields rel­a­tively noth­ing and pro­vides min­i­mal roll­down. Focus on 5–9 year Trea­sury matu­ri­ties to guard against infla­tion which cre­ate oppor­tu­ni­ties to take advan­tage of roll­down cap­i­tal gains.

3. Long Trea­sury matu­ri­ties should be held in TIPS form.  If infla­tion really is com­ing, then an investor will want assets that offer inflation-protection.

4. Cor­po­rate credit pur­chases should be in higher-rated   A and AA paper. Senior as opposed to sub­or­di­nated hold­ings in finance/bank debt should be con­sid­ered as well. Hair­cuts ahead?

5. U.S. munic­i­pals rep­re­sent an oppor­tu­nity from the stand point of val­u­a­tion. Their yields of 5–6% are near his­tor­i­cally high ratios to Trea­suries. They do, how­ever, entail risk – not only volatil­ity but occa­sional default risk. This is not a Mered­ith Whit­ney echo but sim­ply a recog­ni­tion that you usu­ally get what you pay for in this world and noth­ing comes for free. Be selec­tive and avoid states/municipalities with pen­sion and fund­ing problems.

6. Con­tinue to avoid Venus fly trap periph­eral Euroland paper. Ital­ian bonds at 7% for instance are entic­ing but have trap door pos­si­bil­i­ties that could see fur­ther “price” defaults in 2012.

Stocks and commodities

1. Stocks yield more than bonds and will tend to do bet­ter in any­thing but a delev­er­ing fat left tail. That, how­ever, is what wor­ries us. Equity allo­ca­tions, there­fore should favor higher yield­ing com­pa­nies in sec­tors with rel­a­tively sta­ble cash flows: Elec­tric util­i­ties (yes they appear over­bought), big pharma and multi­na­tion­als should head your shop­ping list.

2. Com­modi­ties could go either way depend­ing on the tails but scarcity and geopo­lit­i­cal con­sid­er­a­tions (Iran) favor a pos­i­tive tilt. Gold at $1,550 seems pricey but it has upward legs if QEs continue.

Cur­ren­cies

The dol­lar is king with a left-tailed delev­er­ing sce­nario – pau­per in a right-tailed global refla­tion­ary expansion.

Sum­mary

For 2012, in the face of a delev­er­ing zero-bound inter­est rate world, investors must lower return expec­ta­tions. 2–5% for stocks, bonds and com­modi­ties are expected long term returns for global finan­cial mar­kets that have been pushed to the zero bound, a world where sub­stan­tial real price appre­ci­a­tion is get­ting close to math­e­mat­i­cally improb­a­ble. Adjust your expec­ta­tions, pre­pare for bimodal out­comes. It is dif­fer­ent this time and will con­tinue to be for a num­ber of years. The New Nor­mal is “Sub,” “Ab,” “Para” and then some. The finan­cial mar­kets and global economies are at great risk.

Click here for the full article.

Bill also shared his views in the fol­low­ing inter­view with The Wall Street Journal:

Source: Bill Gross, PIMCO – Invest­ment Out­look, Jan­u­ary, 2011 and The Wall Street Jour­nal, Jan­u­ary 4, 2012.

Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.

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