– Bill Gross, “Damages” October 2012
The quote above is slightly out of context. Bill Gross is discussing his long-term outlook for US financial assets, if the US government does not get its house in order. However, Bill Gross considers the steps taken so far to address the problem as minimal. With this outlook, the natural question is where should one invest? PIMCO is neither shy, nor coy about its investment views. In the last couple weeks, PIMCO has published several articles describing exactly what they see as the best investment opportunities.
Treasury Inflation Securities (TIPS)
With nominal rates close to the zero bound, we believe QE3 will lead to even lower real yields and higher inflation expectations, an attractive scenario for investors in TIPS.
– PIMCO, “The New TIPping Point” October 2012
I want to emphasize the words “higher Inflation expectations”. In the report that the quote is taken from, there is a chart of the volatility of inflation expectations. In January 2012, the volatility of inflation expectations dropped dramatically when the FED came out with a 2% inflation target. However, there are many signs since then that the FED is not very concerned about inflation. Despite inflation being around 2.1% (higher than the target), the FED initiated QE3, which the market believes will be inflationary. In other words, the FED’s highest priority is economic growth, rather than inflation. This change in the FED’s stance is likely to fuel long-term concerns about inflation and increased demand for TIPS.
Look to hold high quality municipal bonds with a focus on essential service revenue bonds such as water and sewer, power and airports.
– PIMCO, “Monthly Commentary – Total Return Fund” September 2012 (published in October)
PIMCO has been increasingly buying municipal bonds for both the PIMCO Total Return Mutual Fund and the PIMCO Total Return ETF. Traditionally, AAA rated municipal bond funds yield less than treasuries of the same maturity. While considered almost as safe as treasuries, AAA municipal bonds have major tax benefits. The last few years, AAA municipal bonds have yielded more than treasuries. (see the LB Rating for the PIMCO Total Return Fund here)
Is Bill Gross making a relative value play? Yes. But he might also think there may be a catalyst for municipal bond values rising. There has been chatter that the Municipal bond tax benefit will be eliminated by Congress in order to increase tax revenues. Bill Gross believes that if this happens, existing municipal bonds would be exempt from this change and would become more valuable.
High Quality Corporate Financial Bonds
In the same monthly commentary letter mentioned above, PIMCO said that they favor high quality financial bonds versus other types of corporate bonds. Learn Bond’s took a look at their top corporate financial bond holdings to see what they liked.
AIG, CitiGroup and Ford Motor Credit came up several times. For those that like to buy individual bonds, here are some CUSIP numbers to look up: