If you aren’t familiar with Bill Gross, he is the Chief Investment Officer of PIMCO, the world’s largest bond fund shop. PIMCO manages over $1.2 trillion. It’s not easy to slosh around over $1 trillion without moving markets. If you invest in bonds it behooves you to carefully monitor what PIMCO is doing.
From Bill Gross’s February 2011 Investment Outlook
Sounds like Mr. Gross has had enough of Ben B.’s asset-price based monetary policy strategy.
“This metaphorical devil’s bargain has its equivalent in the credit markets these days. Central bankers have lowered the cost of money for 30 years now, legitimately following global disinflationary forces downward, but also validating increased leverage via lower real interest rates. Today’s rock-bottom yields, however, have less to do with disinflation and more to do with providing fuel for an asset-based economy that promotes unsustainable wealth creation and a false confidence in perpetual capital gains. Real 10-year interest rates fell from over 5% in the early 1980s to just under 1% in recent months and have arguably been responsible for 3,000–4,000 Dow points and 2–3% annual appreciation in bonds over those three decades.”
The Fed is confiscating money from the small saver, insurance companies, and pension funds and transferring it to the banks.
“To rebalance debt loads and re-equitize financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders and giving it to another. A low or negative real interest rate for an “extended period of time” is the most devilish of all policy tools. And the asset class holder that it affects, or better yet, “infects,” is the small saver and institutions such as insurance companies and pension funds that hold long-term fixed income assets. It is anyone who holds bonds with coupons that cannot keep up with inflation or the depositor in a local bank who cumulatively holds trillions of dollars in time deposits that don’t earn a real rate of interest. This is the framework that has been created by modern-day policymakers who have innovated far beyond their biblical counterparts. To put it bluntly, they are robbing savers and taking money surreptitiously from longer-term asset holders who are incorrectly measuring future inflation.”
A call to sell U.S. Treasuries
“Well, not so fast. This lad and this company are not going away so easily. Devils may or may not be present in this earthly world, depending on your point of view, but if they are, there’s a good chance that exorcists do too and PIMCO’s got just the antidote. Instead of accepting historical durational risk and the prospect of a barbershop quartet of possible haircuts, bondholders should recognize that yield or “spread” comes in different varieties. Maturity extension is just one of them, yet if yields are too low based on historical example, an investor should analyze other yields or other “spreads” which are not. That is what we call “safe spread” – the recognition that credit spreads, or emerging market returns, or currencies with positive and high real interest rates are more attractive than those old-fashioned gilts and Treasury bonds offering 2–3%. Those are markets that need to be “exorcised” from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint.”
Jeremy Jones, CFA
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