PIMCO — May Investment Commentary
Kurt Brouwer May 1st, 2008
Bill Gross made some interesting points in Pimco’s May investment commentary with regard to the investment environment for fixed income. He framed the commentary around a book about World War I — All Quiet On the Western Front, an anti-war novel by Erich Maria Remarque. The book was made into a movie in 1930 and I believe it won an Oscar.
Essentially, Gross is saying things are quiet now, but the war — that is, the financial crisis — is not necessasrily over.
The first points he makes below demonstrate Pimco’s investment strategy in light of the subprime crisis. They correctly saw this financial crunch coming, but there were some ‘white knuckle’ moments for them because their timing was off a bit [emphasis added below]:
All Quiet On The Western Front (PIMCO, May 2008, Bill Gross)
…For PIMCO though, at least from the standpoint of my biased and vulnerable memory bank, there has been a consistent and easily definable plan ever since late 2006:
- Avoid the subprime mortgage meltdown and prepare portfolios for the consequences of a housing downturn. (Mission accomplished!)
- Anticipate the monetary policy changes of the Fed by purchasing high quality front-end investments that would benefit from Fed Funds cuts to as low as 2%. (Mission nearly accomplished!)
- Reinvest in high-quality financial institutions which suffer capital impairment during the anticipated recession. (Mission uncertain!)
- Ultimately invest in lower quality bonds as corporate defaults rise to peak levels. (Mission for the future.)
- Be mindful at all times of the effects of a globalized economy/financial marketplace and its consequences for real interest rates, inflation, and currency levels. (Mission ongoing.)
While this plan has obviously been quite successful to date, it hasn’t come without risk nor sleepless nights. The first half of 2007 was fraught with self doubt and hundreds of “expletives deleted” amongst the PIMCO platoon pinned down in the trenches of a bulled-up credit market where seemingly nothing could go wrong to shake the confidence of levered investors….Ah, but then the pivotal turning point – the collapse of the Bear Stearns hedge funds in June of 2007, the horrific days of mid-August, and now the aftermath of another Bear Stearns debacle one year later. We have not only survived, but gained territory and are eager for further advances.
…To be brief and blunt, the reason that home prices are so critical…is that they are at the forefront of potential asset deflation. Because the U.S. and selected other economies are now substantially asset-based and dependent on stable and upward tilting prices, a deflation of an economy’s primary financial asset can be ruinous.
For more on this point, see Bill Gross — Stop Falling Home Prices Now.
…For now, all is quiet on our investment front and the war appears to be winding down. We remain on the alert however as we seek to implement step #3 and eventually step #4 of our investment battle plan. Remarque wrote of his WWI soldiers: “We live in the trenches…we fight. We try not to be killed. Sometimes we are. That’s all.” At PIMCO, with a much less dangerous but perhaps equally probabilistic occupational outcome, we will keep our heads low in hopes of fighting for another day…
As you can see from this post, PIMCO Buys Citigroup Bonds, Pimco is already engaged in number three above. I wonder when the point will come for them to move to number four above. We’ll keep our eyes out for that.
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