Below is an excerpt summarizing bond investment recommendations from the PIMCO head Bill Gross’ January 2009 Investment Outlook.
PIMCO’s view is simple: shake hands with the government; make them your partner by acknowledging that their checkbook represents the largest and most potent source of buying power in 2009 and beyond. Anticipate, then buy what they buy, only do it first: agency-backed mortgages, bank preferred stocks, and senior bank debt; Aaa asset-backed securities such as credit card, student loan, and auto receivables. These have been well-advertised PIMCO strategies over the past 6 months but there are others in clear sight. An Obama administration will quickly be confronted by the need to provide those hundreds of billions of dollars to states and large municipalities. Their requests total nearly a trillion dollars and to think California or NYC would be allowed to fail is, well – unthinkable. Municipal bonds then, selling at historically high ratios relative to U.S. Treasuries, offer attractive price appreciation potential, or at the very least a defensiveness with high carry that a 2½% 10-year Treasury cannot.
As Gross reminds us, they’ve been telling people for months to invest in certain bonds ahead of the government. That’s why mortgage rates dropped 1.25% from November 24 to January 5—this was the period that private investors piled into mortgage bonds after the Fed said they’d be buying $500b in mortgage bonds. They only started buying bonds on January 5, and after $33.6b of purchases, rates are net even—ostensibly because private investors are exiting.
This isn’t to say that rates won’t drop further on more Fed buying, but it makes the point clear that Fed buying will only take rates down so low because private investors will exit after the Fed gets in. Ponzi Nation as Gross puts it.
Gross discusses the debate of which approach to take out of Ponzi Nation here:
Better, some thought, to have followed the advice of early 1930s Treasury Secretary Andrew Mellon: “Liquidate labor, liquidate stocks, liquidate the farmers – purge the rottenness from the system.” The Mellons of the world argued that bailouts were akin to pouring gasoline on a fire, adding trillions of dollars of new debt to a domestic and global economy that had broken down because of, because of, well, because of – too much debt.
Wall Street, the Fed, and Newport Beach took the other side. Those steeped in economic history felt that the Great Depression and more recently the “lost decade” in Japan had both experienced a “liquidity trap,” a monetary black hole where lenders, savers, and ultimately consumers were frightened into stuffing their money into a mattress rather than circulating it in classic capitalistic fashion. Sensing a freezing of credit markets following the default of Lehman Brothers, policymakers decided it was better to become a bailout nation than a sunken ship.
Then here’s his conclusion where he warns of the perils of buying our way out of this situation, but sticks to his approach, which is to avoid a long-term downturn, which of course nobody can predict. All we can do is choose a side and execute our strategy. The rest is just chatter. And with the new administration taking over tomorrow, there will surely be plenty of chatter.
There is legitimate concern as to the ultimate destination and outcome of our “bailout nation.” Realistically, quantitative easing, a two-trillion-dollar expansion of the Fed’s balance sheet, and the near certainty of future budget deficits approaching 6-7% of GDP should alert bond investors to once again become vigilant as was the case in the 1980s and 90s. Vigilantes we should be, but that is a battle to be fought in the Treasury market where low yields offer little reward and increasing risk. For now, our Ponzi-style economy and its policy remedies encourage bond investors to mimic Uncle Sam and its global compatriots. Buy what they buy, but get there first. Andrew Mellon would surely have disapproved. Liquidation was his game. Wimpy? Well, he’s gonna have to start paying for those burgers on Monday, even in a bailout nation.