Pimco March Investment Outlook
Kurt Brouwer February 27th, 2008
Bill Gross and bond fund giant Pimco have just released the March Investment Outlook and it is actually somewhat optimistic. Based on this commentary and other indicators, I think the folks at Pimco are seeing buying opportunities these days [emphasis added]:
Investment Outlook — No Country For Old Maids (PIMCO, March 2008, Bill Gross)
“…The investor’s task, however, is not to pillory or even desert the game, but to accomplish three primary tasks: 1) continue to ask “Who’s got the Old Maid?”, 2) understand and forecast the game’s economic and policy consequences, and 3) formulate a portfolio (to paraphrase Will Rogers), that maximizes the return on capital as well as the return of capital.
To elaborate on #2, it seems obvious that players are getting tired of playing games and that a prolonged period of risk aversion and deleveraging of our global shadow banking system lies ahead. Tighter lending standards, reduced risk budgets, and increased regulatory scrutiny all promise to produce a reduction in the growth rate of lending…
…Slow credit growth is a harbinger, however, for slow economic growth (if any) and that in turn leads to the necessity for low short-term interest rates for an extended period of time. I think Ben Bernanke knows that restarting the U.S. growth engine almost by definition requires nominal GDP growth of 5%. He’d prefer that nominal rate be composed of 3% real and 2% inflation, but desperate times sometimes require compromise: 2% real and 3% inflation may be the best he can hope for in 2009 as soaring commodity prices and a declining dollar add to the equation’s complexity. If so, a bond investor should expect a prolonged, several year period of low short-term rates (Fed Funds averaging 2½%) with vulnerability on the intermediate and long-term portions of the U.S. curve due to inflationary fears and the diminishing support of foreign central banks and SWFs. If, as a bond investor, I expected 3% inflation (2% in 2008 - higher in the out years), a 3% 5-year Treasury would not seem very appealing. Nor, I should add, would a 3.80% 10-year or a 4.65% 30-year bond.
I think you can read this to mean that Gross does expect 3% inflation this year and he is investing accordingly (see below).
This leads me to #3 on my list of action plans. What should an investor do - desperately trying to avoid the Old Maids, yet trapped with good Treasury cards at yields inappropriately low in a mildly inflationary future environment? The answer lies in managing a transition to riskier assets while being acutely aware, as my CIO partner Mohamed El-Erian is quick to point out, that such a transition will be characterized by technical purges of Old Maid and even higher quality assets that in many cases produce price levels significantly below what might at first seem reasonable. Minsky moments [for more on Hy Minsky see George Soros, Hy Minsky and Matt Millen]- the unwinding of levered assets - produce as many surprises on the downside as do $5 million dollar homes in Silicon Valley and NASDAQ 5,000 point stocks on the upside. Patience and cognizance of flows, El-Erian counsels, are as critical to the equation as is the recognition of the Old Maids in the first place.
Still, we would both agree that value is returning to many parts of the bond market. If an investor requires 5%+ yields to compensate for future inflation, then they can increasingly be found in authentic AAA assets - not disguised Old Maids. There’s not a hint of plastic surgery in agency-backed FNMA and FHLMC mortgages at 5¾%, although their actual ages (average lives) may be somewhat in doubt. Similarly, SBA government-guaranteed loans at LIBOR+ 125 basis point yields are beginning to entice, as are some of those bank loans when priced in the high 80s as opposed to 95 cents on the dollar. If capitalism is a going enterprise - and we think it is - then investors will eventually return to play similar, perhaps more conservative games - much as they have in the past. And if Washington gets off its high “moral hazard” horse and moves to support housing prices, investors will return in a rush. PIMCO wants to sit at this more attractive return table - to provide an attractive return on your money (no matter what the asset class) as well as a return of your money…”
Don’t kid yourself. Pimco is already playing at the more attractive return table (see PIMCO Buys Citigroup Bonds). This is a good time to be an opportunistic investor in the bond markets and Pimco is all that and more — in spades.
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