PIMCO's Bill Gross Favors Quality Credit Spread Over Duration Extension (April 2010 Commentary) ~ market folly

Friday, April 9, 2010

PIMCO's Bill Gross Favors Quality Credit Spread Over Duration Extension (April 2010 Commentary)

Today we wanted to highlight the latest investment outlook from PIMCO's bond vigilante himself, Bill Gross. In his past March commentary, Gross focused on corporate versus sovereign bonds. His April commentary is entitled 'Rocking-Horse Winner' and it centers on American capitalism and how it is driven by printing, lending and borrowing money in order to make more money. Gross immediately notes that we face an environment with lower growth due to headwinds in deleveraging, deglobalization, and reregulation. Gross of course recently landed on Forbes' billionaire list, joining many prestigious investment managers.

The crux of Gross' message this time around comes later in his insight where he writes,

"The reason is complicated, but at its core very simple. As a November IMF staff position note aptly pointed out, high fiscal deficits and higher outstanding debt lead to higher real interest rates and ultimately higher inflation, both trends which are bond market unfriendly. In the U.S. in addition to the 10% of GDP deficits and a growing stock of outstanding debt, an investor must be concerned with future unfunded entitlement commitments which portfolio managers almost always neglect, viewing them as so far off in the future that they don’t matter. Yet should it concern an investor in 30-year Treasuries that the Congressional Budget Office estimates that the present value of unfunded future social insurance expenditures (Social Security and Medicare primarily) was $46 trillion as of 2009, a sum four times its current outstanding debt? Of course it should, and that may be a primary reason why 30-year bonds yield 4.6% whereas 2-year debt with the same guarantee yields less than 1%. The trend promises to get worse, not better."

Elaborating further on his thoughts, it's clear that Gross favors quality credit spread over duration. He argues that investment strategies should start to position themselves on the front-end of various yield curves that are subject to successful reflation. He specifically highlights the US and Brazil here. He also recommends positioning on the long end of curves that can survive debt deflation (namely Germany and most of the solid European nations).

Lastly, Bill Gross notes that, "Spreads in appropriate sovereign and corporate credits are a better bet as long as global contagion is contained. If not, a rush to the safety of Treasury Bills lies ahead." You can directly download Bill Gross' entire April 2010 investment outlook via .pdf here.

Interesting thoughts as always from PIMCO's bond vigilante and we'll continue to check in with him each month. You can also check out his March commentary as well as our compilation of investment insight from various gurus.

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