Bill Gross, PIMCO’s founder, managing director and co-CIO, says – when it comes to bonds – the times are indeed changing, now that the Federal Reserve has announced a second round of long-term Treasury bond purchases to the tune of $600 billion, referred to as QE2.
“The Fed’s announcement will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment,” he wrote in a November commentary released at the end of last month.
“Bondholders, while immediate beneficiaries will likely eventually be delivered on a platter to more fortunate celebrants, be they financial asset classes more adaptable to inflation such as stocks or commodities …,” Gross added.
The Fed’s bond buying “raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead-end where those prices can no longer go up. Having arrived at its destination, the market then offers near zero percent returns and a picking of the creditor’s pocket via inflation and negative real interest rates. A similar fate, by the way, awaits stockholders, although their ability to adjust somewhat to rising inflation prevents such a startling conclusion,” he explained.
On a positive note, however, he says there are other ways to invest, which he calls “safe spreads:” developing/emerging market debt with higher yields and non-dollar denominations, along with high- quality global corporate bonds. “Even U.S. Agency mortgages yielding 200 basis points more than those 1-percent Treasuries, qualify as ‘safe spreads,’ ” Gross explained.
“While our ‘safe spread’ terminology offers no guarantees, it is designed to let you sleep at night with less interest rate volatility,” he added. Bernanke’s action may or may not work, Gross concludes, “but either way it will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.”
On Nov. 1, Gross said that he expects also expects the dollar to decline by about 20% over the next few years due to QE2. As a result, he added, Americans should be investing more overseas where growth is strong.
Meanwhile, PIMCO CEO Mohamed El-Erian said in an interview Tuesday with The New York Times that the Federal Reserve’s decision to buy up to $600 billion in government bonds does not go far enough in solving U.S. financial and economic issues.
Though QE2 may reduce the risk of deflation and a double-dip recession, it will not address the “unusual” period of low growth and stubbornly high unemployment set to linger for several years, he said.