PIMCO's Bill Gross On Corporate Versus Sovereign Bonds: March Commentary ~ market folly

Wednesday, March 3, 2010

PIMCO's Bill Gross On Corporate Versus Sovereign Bonds: March Commentary

Bill Gross is out with his latest commentary from PIMCO. In his March 2010 investment outlook entitled 'Don't Care', Gross focuses on the lack of global aggregate demand and how we got into this whole situation. The first part of his commentary doesn't really focus on markets, but rather on social situations. It is still comical (and shockingly somewhat true) and eventually ties into his market discussion, providing a decent analogy. Previously, we've also posted Gross' previous outlook as well as his thoughts on why the market is up so much from the lows.

Given Gross' natural focus on all things fixed income, he comments on how sovereign bonds have been hit hard and as of late have even been surrounded with more negativity than corporate debt. With the recent wave of default concern, it's intriguing that the roles of these types of bonds have flipped. Previously, sovereign bonds were considered safer than corporates. Nowadays, investors are re-considering and some corporates now look safer than some sovereigns. In terms of recommendations, he likes strong sovereign bonds including Germany and Canada.

Gross writes,

"It is interesting to observe that over the past few months when investors have begun to question the ability of governments to exit the debt crisis by “creating more debt,” that increases in bond market yields have been confined almost exclusively to Treasury/Gilt-type securities, and long maturities at that. There has even been a developing debate in the press (and here at PIMCO) as to whether a highly-rated corporation could ever consistently trade at lower yields compared to its home country’s debt. I suspect not, but the narrowing in spreads since late November solicits an interesting proposition: Government bailouts and guarantees such as those evidenced and envisioned in Dubai and Greece, as well as those for the last 18 months with banks and large industrial corporations across the globe, suggest a more homogeneous “unicredit” type of bond market. If core sovereigns such as the U.S., Germany, U.K., and Japan “absorb” more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee. The Kings, in other words, in the process of increasingly shedding their clothes, begin to look more and more like their subjects. Kings and serfs begin to share the same castle.

This metaphor doesn’t really answer the critical question of whether a debt crisis can be cured by issuing more debt. The answer remains: It depends – on initial debt levels and whether or not private economies can be reinvigorated. But it does suggest the likely direction of sovereign yields IF global policymakers are successful with their rescue efforts: Sovereign yields will narrow in spreads compared to other high-quality alternatives. In other words, sovereign yields will become more credit like. When sovereign issues become more credit-like, as evidenced in Greece, Spain, Portugal, and a host of others, they move closer in yield to the corporate and Agency debt that supposedly rank lower in the hierarchy. That process of course can be accomplished in two ways: high-quality non-sovereigns move down to lower levels or governments move up. The answer to which one depends significantly on future inflation, the aftermath of quantitative easing programs, and the vigor of the private economy going forward. But the contamination of sovereign credit space with past and future bailouts is a leveler, a homogenizer, a negative for those sovereigns that fail to exert necessary discipline. Only if global economies stumble and revisit the recessionary depths of a year ago should the process reverse direction and place Treasuries, Gilts, et al. back in the driver’s seat."

To read the rest of Bill Gross' commentary, directly download it via .pdf here.

For more investment insight from market gurus, check out Warren Buffett's annual letter as well as Eddie Lampert's annual letter. Additionally, make sure to check out our past coverage of a ton of very insightful commentary from hedge funds.

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