A Bond King Turns Bearish

The almost three-decade bond market rally may be drawing to a close, says Bill Gross, manager of the $214 billion Pimco Total Return Fund (PTTRX), the world's largest bond fund. "Bonds have seen their best days," Gross told Bloomberg Radio in a Mar. 25 interview. "Real [inflation-adjusted] interest rates are moving higher." Yields on two-year U.S. Treasury notes are likely to rise from 1.08% to 1.25%-1.5% in the next year as the economy strengthens and the Federal Reserve begins to raise interest rates, he says. When rates go up, bond prices go down, and that means a bearish market for bondholders. Pimco Total Return had a 16% gain in the past year, beating 54% of its peers, according to data compiled by Bloomberg.

Under what Pimco calls the "new normal," investors should expect lower-than-average historical returns with heightened government regulation, lower consumption, slower growth, and a shrinking global role for the U.S. economy. Huge borrowing in nations including the U.S., U.K., and Japan will eventually lead to inflation as governments sell record amounts of debt to finance surging deficits, Gross predicts.


Pimco, which announced in December it would offer stock funds for the first time, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher-yielding corporate securities. In a recent investor commentary, Gross recommended avoiding U.K. debt and buying shorter-maturity U.S. and Brazilian government bonds, as well as longer-maturity German and "core" Europe bonds.

Gross increased holdings of bonds from non-U.S. developed nations in his Total Return Fund for a fourth straight month in February, taking them to the highest level since May 2004, according to data on the company's Web site. He increased government-related debt to 35% from 31%, the first rise since October 2009, and lowered net cash to 2% from 9%. U.S. Treasuries have returned 0.9% this year, compared with 2.7% for German government bonds and 0.5% for U.K. gilts, according to indexes compiled by Bank of America Merrill Lynch (BAC).


Gross's global focus extends beyond bonds. The No. 1 thing Americans should do to try to make back wealth is to "move outside of the United States" in choosing stocks, he says. Many companies in the S&P 500 do have global businesses, he notes, but the focus should be on emerging and developing countries because they are now "creditor countries" that feature strong growth. Developed countries are now the "debtor countries" and face weaker growth. "What an investor wants to do, either from a standpoint of stocks or bonds, is go to countries with high real [inflation-adjusted] interest rates," says Gross. The "typical suspects" to invest in include Brazil, China, and India, he adds. There is a caveat to emerging-market investments, says Gross. Emerging countries can have problems in terms of asset bubbles and property rights.

Pimco filed with regulators last December to start a stock fund that can invest in bank loans, junk bonds, and distressed securities. The Pimco Global Opportunities Fund will buy securities and financial instruments "economically tied" to at least three countries, one of which may be the U.S., according to a company filing.

Whatever approach investors take with their bonds, Gross suggests a wise motto to adopt in his latest investor commentary: When evaluating sovereign debt, "Don't trust any government and verify before you invest."

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