Quarterly Outlook

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That the world’s a risky place has not escaped the recent attention of investors. The potential demise of the European single currency and perhaps with it European banks and the European project itself looms large over every investment decision, and has for many months. Economic slowdown in China, the uncertain consequences of the Arab Spring and more recently Iran’s nuclear ambitions all add to the global uncertainty. Within the U.S. a highly partisan Congress has led to legislative gridlock and no certainty about long term fiscal policy. It makes you wonder how investors get out of bed in the morning. And when they do, they are confronted with a choice of risky assets (such as equities) which may lose value immediately, or less risky assets (such as bonds) which will lose real value with certainty. That investors are choosing the certainty of lost purchasing power over the available alternatives reflects the seemingly poor choices on offer. Thus is the equity risk premium, the difference between the earnings yield (inverse of the P/E ratio) on the S&P500 and the ten year U.S. treasury yield, at its widest since 1974, a year that closed with the Dow Jones Industrial Average having dropped 45% from its peak only eighteen months earlier, and inflation at 12.3%.

Start with bonds. Today’s ten year treasury yield of around 2% assures even the tax-exempt hold-to-maturity investor of a loss in purchasing power if inflation over ten years exceeds 2%. The taxable investor of course will fare even worse. Even a portfolio of blue chip corporate bonds yielding around 4% will struggle to overcome the twin headwinds of taxes and inflation. But bonds have a big thing going for them, which is momentum. For those who draw comfort from investing with a tailwind, bonds are a warm and cozy place. The Dow Jones Corporate Bond Index has returned 10% per annum for the past three years including 8.5% in the most recent one.  Who’s to say that this won’t continue? And of course it may, although such forecasts will struggle mightily to overcome the Math; for bonds to return more than their current yield, their yields need to fall causing prices to rise. Corporate bond yields could drop from 4% to 3%, although such would presumably require a similar drop in treasury yields, to 1%. The world in which 1% ten year treasuries draws buyers is unlikely to be a friendly one for corporate credit, and at such a time credit spreads might be substantially wider, depressing the prices of corporate bonds. So, much as bonds investors might draw comfort from looking backwards, their best plausible outcome is that they’ll earn the current yield and suffer a steady depreciation in the real value of their assets.

In fact, relative pricing between stocks and bonds is such that $20 invested in the S&P500 yielding 2% will, assuming 4% dividend growth (and the 50 year average is 5%) generate the same increase in after-tax wealth as $100 in ten year treasuries. This assumes the $80 not invested in stocks earns 0% by sitting in cash, although holding cash provides the option to do something with it that might well earn a return later on. The Math works for corporate bonds as well (just change the $20 in stocks to $40).

So bonds have been good, but past performance is highly unlikely to be repeated. In fact, we believe there’s a strong case to be made for all investors to reduce their asset allocation to fixed income. Government policy is to maintain ruinously low interest rates while debtors rebuild their balance sheets. The Federal government is effecting a transfer of real wealth from investors to borrowers. This policy is likely to continue for quite a long time, not least because it’s popular (with those voters who contemplate such things). There are many more debtors than creditors, and regardless of how independent you think the Federal Reserve is, monetary policy is unambiguously populist, designed for the masses. The appropriate response is to allow the government’s voracious appetite free rein. If Chairman Bernanke likes bonds that much he can have the lot.

As a result, identifying alternatives sources of investment income is a task that consumes much energy on a daily basis at SL Advisors.

The stock market offers a risk to suit every taste. For those who like to wake without first worrying whether their holdings are solvent, many reasonably priced large cap companies with low levels of debt and a history of steady earnings growth are available. Kraft (KFT), Microsoft (MSFT) and Berkshire Hathaway (BRK-A) are all examples in our Deep Value Equity Strategy, along with less well-known names such as Corrections Corp (CXW) and Republic Services Group (RSG). Domestic energy exposure adds volatility and return potential through Devon Energy (DVN) and Comstock Resources (CRK). The former bond investor can allocate his new funds to a combination of stocks and cash (depending on risk appetite), or to other income generating strategies.

There are even examples of stocks whose dividend yield exceeds that on their own bonds – not because their fortunes have suffered and a high dividend yield reflects expectations of a cut, but because price-insensitive bond investors have driven bond yields low in their flight from equities. Johnson and Johnson (JNJ) is one such example. Our Dividend Capture Strategy consists of a diversified portfolio of such names combined with a hedge to eliminate most of the daily market moves. The result is a portfolio exposed to dividend paying stocks and dividend growth that is hedged against excessive moves in stocks.

Master Limited Partnerships (MLPs) are another attractive asset class for taxable investors tolerant of K-1s. I won’t repeat here the well-worn arguments that are familiar to regular readers, except to note that the sector’s unique structure renders it worth having in many income-seeking portfolios. MLPs offer tax-deferred distribution yields of 5-6% combined with growth expectations of 4-6% (suggesting a total return potential of 9-12% with no change in earnings multiples).

Disclosure: Author is Long KFT, MSFT, BRK-B, CXW, RSG, DVN, CRK, JNJ

MLPs Offer Steady Income and Exposure to Shale Gas Development

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The New York Times today has a piece on Richard Kinder, founder of Kinder Morgan (KMP) the largest publicly traded partnership in the U.S. KMP recently agreed to acquire El Paso Corporation to create an entity controlling 80,000 miles of pipeline crisscrossing the U.S. KMP is a Master Limited Partnership (MLP), which is to say that owners of LP units (as their shares are known) own a proportional stake in the underlying assets rather than shares in a corporation. The big advantage of this structure is that there is no 35% corporate income tax, so the profits flow straight through to the unitholders without the double taxation that occurs when corporations use after tax profits to pay dividends that are themselves taxable. MLPs and KMP in particular also represent an investment in the growth of natural gas as a source of America’s energy production. Cheap shale gas is increasingly being used to produce residential electricity. From 2005-2010 consumption for this purpose grew from 5.9TCFE (Trillion Cubic Feet Equivalent) to 7.4TCFE, more than 70% of the increase in total natural consumption to 24TCFE last year (according to the EIA). A shifting mix of energy sources requires new infrastructure to transport, store and refine it, which is what KMP recognizes. JPMorgan initiated coverage on the sector in October and expects $130BN in infrastructure spending over the next 10 years.

KMP pays a $4.64 distribution, giving a current yield of 5.9%. They’ve grown this distribution at a compound annual rate of 14%. This is high for an MLP, but 6% annual distributions with likely growth of 4-6% over the next 2-3 years is a reasonable assumption, offering the potential for 10-12% total return (assuming multiples are unchanged). Distributions are also largely tax-deferred, since much of the cash received by unitholders is classified on their K-1 as a return of capital, rather than income. Ah yes, you have to deal with a K-1 instead of a 1099. They’re not for everybody, and unless you use a tax accountant and can afford to invest at least $250K in a diversified portfolio of individual names this sector is probably not for you. But for high net worth investors interested in a 6% tax deferred distribution yield with likely 4-6% growth and tolerant of K-1s, this is a sector that belongs in most portfolios. In fact, I think MLPs are a great substitute for high yield bonds. They exhibit similar levels of price volatility (in a weak equity market they can fall farther than you’d like) but offer better return prospects. While unitholders do own equity interests, the overall risk/return characteristics are more bond-like than equity-like.

MLPs are putting in another solid year, with the Alerian MLP Index returning 7.7% for the year through November. That’s ahead of both high-grade bonds (the Dow Jones Corporate Bond Index is +6%) and the S&P 500 (+1.1%) over the same period.

Government policy is to transfer real wealth from savers to borrowers. Policy rates and bond yields are being maintained at levels so low that, after taxes and inflation savers are virtually guaranteed to lose purchasing power. Bonds have their place in a portfolio, and no doubt there are plenty of issues facing markets right now starting with the Eurozone. But given the guaranteed poor long-term outlook for bonds, we think investors should be reducing their overall fixed income weighting in favor of alternative sources of income (such as MLPs) and dividend paying stocks. Retail investors have been steadily increasing their holdings of corporate debt. For example, the  iShares iBoxx Investment Grade Corporate Bond Fund (LQD) has seen steady growth in outstandings all year. Corporate bonds have been strong performers for the past couple of years, but with yields on high grade bonds currently around 4%, you can only make 4% and after 2.5% inflation there’s about enough to pay taxes and that’s it. The Federal Reserve is causing this distortion in the fixed income markets. They can keep it up for a long time. Today’s fixed income investors are competing with the world’s deepest pocket – it’s probably time to look elsewhere.

 

Disclosure: Author is Long KMP

Bond Math

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You don’t need a degree in Psychology to know that investors are nervous. Pick up any newspaper, or just take your own pulse. Macro issues dominate almost every investing decision, and it’s therefore not surprising that the safety of bonds remains attractive. No doubt fixed income has had a great run. The Dow Jones Corporate Bond Index, a benchmark of long duration investment grade debt, has returned 7.9% p.a. since the beginning of the millennium. The S&P500 has managed 0.5% p.a. over the same period. Investing by looking backwards can be reassuring – generally if something has happened before, it can happen again. Bonds look better than stocks in the rear-view mirror and they can appear pretty compelling looking forward too. If the Euro collapses then for stocks, so goes the conventional wisdom, down is a long way. And so it might be. But here’s the Math. High grade bonds (as defined by the relevant iShares ETF, LQD) yield 4.4%. That is what the hold-to-maturity investor in long-term corporate debt can hope for. Factor in a 40% tax rate on interest payments with 2.5% inflation and it will be hard to maintain purchasing power. Stocks were roughly 2.5 times as volatile as bonds over the last decade – selling those bonds and putting 40% of the proceeds in large cap, dividend paying stocks that yield 3.5% (with the rest, for now, in cash) maintains the same overall portfolio volatility and only requires 3.8% dividend growth to beat bonds (compared with a fifty year growth rate of 5%). The 60% in cash provides a useful option to invest at a later date when prospects are clearer – and who knows, maybe one day interest rates with an integer could return to the money markets. Ben Bernanke is steadily raising the stakes for those bond investors who wish to invest alongside him. The Fed’s QE2 program has created a large and non-commercial buyer for debt that is not motivated by profit. Indeed, the Fed’s objective is to create an environment in which bond investors wish they owned something else. Real returns on investment grade and government debt are likely to remain negative for an extended period of time. The Fed has the ability to ensure this state of affairs persists indefinitely should they so desire. “I promise you negative real returns for many years” may not be a catchy soundbite, but if Chairman Bernanke said those words they would not require any change in monetary policy. While it’s usually good to follow the smart money, in this case it may be academic smarts rather than street smarts that are on display. The most significant long-term challenge facing investors must surely be identifying alternatives to traditional fixed income.

Bond Buyers Drive with the Rear-View Mirror

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Charles Evans, Federal Reserve Bank of Chicago President, was on CNBC yesterday and nicely illustrated why bond yields could stay low for a considerable time. At times sounding as if he was running in a Democratic primary campaign, Evans commented repeatedly on the pain out there in the economy and the chronic unemployment. Interestingly he maintains that the “natural” rate of unemployment remains at 6% even while the numbers of long-term unemployed remains high. The Pew Research Center recently reported that nearly 32% of those out of work haven’t worked for a year – over time leading to an atrophying of skills, reduced employability and ultimately less excess capacity in the labor force as the jobs market moves on. It is no doubt a terrible human tragedy – if only Washington could stumble on the right policies to fix it. But the familiar partisan gridlock remains.

Therefore, since low interest rates are the time-honored solution to economic distress, we face more of the same. It is a recurring irony of recessions that while excessive exuberance and debt generally precede if not cause a slump, much pain is also borne by those whose affairs were managed altogether more prudently. So it is that bond investors today are paying for the sins of their more profligate neighbors through miniscule interest rates that erode the purchasing power of their savings. The over-indebted are helped with a transfer of real wealth from the frugal. Managing your own affairs carefully carries less reward than it might.

A consequence is that dividend yields on a number of blue chip stocks are higher than the yields on their own bonds. This used to be far more common in the early 20th century when bond coupons were regarded much more favorably than uncertain dividends, and you can’t rule out that this state of affairs could persist for many months. It maybe even turn out that this yield advantage of stocks is appropriate for the risk, if we endure a period of protracted slow growth or recession that sees no dividend growth. High dividend yields can indicate corporate stress. Transocean’s stock  (RIG) currently yields 6.4%, but the market recognizes some risk this will be cut, either through continued poor execution by management or following a larger than expected settlement with BP on last year’s Macondo spill. On the other hand, Johnson & Johnson (JNJ) stock yields 3.5%, comfortably above its twelve year bond yield of 2.6%. JNJ is not a stressed company and has raised its dividend annually for 49 years. They’re likely to earn close to $5 per share this year and consensus expectations are for 5% EPS growth in 2012. There are numerous other examples in this article for instance. Pepsi (PEP) and Kimberly-Clark (KMB) probably belong in the same category – companies whose stock is highly likely to outperform its own debt.

Falling and low bond yields have so far not dulled retail investors’ appetite. Strong returns on fixed income in recent years, for those who buy securities because “the chart looks good” reduce their return potential as assuredly as night follows day. The most you can earn on JNJ 6.75% corporate bonds maturing 11/15/2023 and yielding 2.6% is, well, 2.6%. That doesn’t even cover inflation, never mind taxes for the eager, momentum-driven buyer. If that return beats stocks over the next ten years it’s unlikely that most types of corporate risk (credit or equity) will have been comfortable places to be. Is it possible the buyers are actually expecting still lower yields and therefore some capital appreciation? Ben Bernanke has surely demonstrated that yields can always go lower. But if you like JNJ bonds at 2.6%, surely treasury bills for a couple of years at 0% with the retained option to invest on better terms later on must be a viable alternative? With a modified duration of just under 9, if the yield rose to 2.9% the capital loss would eliminate the coupon income. A portfolio of reliably growing, dividend paying stocks either in combination with a beta-neutral hedge or cash is far more attractive than high-grade bonds.

 

Disclosure: Author is Long RIG, JNJ, KMB, PEP

The Euro and Government Bonds Are Likely to be Poor Investments

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While the troubles in the Euro-zone have clearly been a major source of uncertainty for U.S. equity investors, it’s beginning to appear as if negative consequences will be largely imposed on Europeans with manageable fallout elsewhere. No doubt there’s still plenty to worry about and this assessment could be wrong, but the economic data is starting to point that way. EU-zone GDP growth of 0.2% was meager but pretty much as expected – the FT’s headline announcing that “Germany and France drive eurozone growth” seemed at odds with the numbers. Europe doesn’t look as if anyone’s driving except towards a cliff. As a result. it’s increasingly looking as if U.S. and Euro-zone growth will diverge significantly with the tail risk being for an even greater difference. Base Case forecasts from JPMorgan are for 2012 real GDP growth of 1.7% in the U.S. versus -0.6% in the Euro-zone. This is why there’s still a case to be short the €. Even without a financial disaster, plausible baseline assumptions favor the U.S. economy over Europe’s. But before you conclude that all the unthinkable outcomes have already been contemplated, read the op-Ed in the FT by Jim Millstein, chairman of Millstein & Co. Mr. Millstein argues that Europe’s banks are beyond too big to fail – they’re too big to save. The size of Europe’s biggest banks relative to their economies is disproportionate and far larger than in the U.S. If his warning of wholesale sovereign debt writedowns and bank recapitalizations comes true, new sources of private capital will be needed beyond whatever the IMF can supply. It’s a sobering scenario.

At least savers in Italy, Spain and even France are being offered a positive real return on ten year government bonds (nominal yields of 7%, 6.3% and 3.6% respectively). Given the sorry state of developed country finances every where including the U.S., it’s hard to see why anybody would lend to anyone for ten years at low single digit yields. 2% in the U.S. is derisory, and every day the Federal Reserve drives thinking fixed income investors away – to senior loans (we continue to own BHL and PPR) and to MLPs . In fact the 1 year return through October on the Alerian MLP Index AMZ is +7& compared with just 1.1% % for the S&P500 and 2.3% for REITS. MLPs are best accessed through individual holdings in order to fully benefit from the 6% tax-deferred yields available.

Dividend paying stocks remain a valid alternative. Ten year treasuries represent such poor value that only $20 in dividend paying stocks can generate the same after-tax return as $100 in treasuries (assuming 4% annual dividend growth).  A barbell, made up of cash invested in treasury bills and dividend paying stocks, is a valid alternative to today’s overpriced high grade bond market.

Italy's in Play

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At least Italian savers are offered a decent return on their money. 7% on ten-year debt is a bit more like it – at least after taxes and inflation you stand a chance of being ahead of the game, unlike in the U.S. where government policy is hostile to savers and seeks to inflict real losses of purchasing power on anyone desperate enough to invest in government bonds. We could use some Italian yields here in the U.S. However, in Italy there’s just the non-trivial question about ultimate repayment. Meanwhile, Senior loans in the form of two closed end funds, PPR and BHL, yielding around 6% seem a much better bet. Diversified credit risk to leveraged corporate borrowers with short duration, versus concentrated sovereign credit risk with dysfunctional government and long duration. There’s no yield at which we’d invest in Italy; we did buy more of these two funds yesterday.

If the sellers of Italian bonds over the past few days have been banks, it would be wholly understandable. The “voluntary” 50% haircut they agreed to over Greece clearly sets a precedent rather than being unprecedented. Combined with the natural consequence that sovereign credit default swaps have questionable value (since the 50% write-down likely won’t trigger a default event) return of capital is trumping return on capital. Forecasting where the crisis will end remains a complex struggle, but by now we’re becoming trained to contemplate the unthinkable. Markets even seem to have moved beyond the EFSF and that leaves just the IMF to bail out with real money and strings attached, or ultimately the ECB to create money. What a surreal outcome that would be given that the ECB’s constitution was modelled on the Bundesbank’s and more or less dictated by Germany. And of course it may not happen. But with Italy now “in play” so to speak, yet another unthinkable is now a headline. German policymakers will have to wrestle with their deep-seated fear of inflation and their perhaps equally strong desire to maintain the Euro in is present form. We maintain a short € position (through being long EUO) as a hedge on some of our leveraged strategies. We reduced the position yesterday – it’s not that the crisis is over, but obviously everyone gets the joke by now so the $/€ exchange rate provides less protection than it used to.

 

Disclosure: Author is Long PPR, BHL, EUO

Another Day, Another Euro Crisis

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Of the many ways in which Silvio Berlusconi thought he could be forced from power, rising Italian bond yields was probably not high on his list. Even his titillating escapades seemed to have been insufficient to persuade the Italian electorate he should leave. But it turns out 7%+ bond yields, with €300Bn of new borrowing required in 2012, is the the breaking point. Less than a month ago the focus was on Greece and building a secure firewall with the EFSF to prevent contagion spreading to Spain or Italy. Now here we are, and we’re running out of unthinkable developments.

It’s not that Europe doesn’t possess the savings to fund profligate countries while they adopt the German fiscal model. It’s just that the money is in the wrong place – northern Europe not Southern.

So another test of equity investors’ fortitude looms. The S&P 500 (SPY) will once again shift from greed to fear. But it’s always worth looking at the fundamentals of the companies you own. For example, in our Hedged Dividend Capture Stategy, McDonalds (MCD) reported 5.5% Year-on-Year sales growth in restaurants open more than a year. Even in Europe sales grew 4.8%. It yields 3% (more than 1% over ten year U.S. treasuries) and could grow earnings at 10% next year. Kraft (KFT) just revised up their 2011 guidance from $2.25 to $2.27 and continues to exploit synergies from their Cadbury’s acquisition. KFT is also likely to grow at double digits as it prepares to break itself up into two companies and yields 3.3%, more than 1.3% over ten-year U.S. treasuries. The Federal government wants your tax dollars, but really doesn’t want your savings. That’s the message of today’s bond yields.

The near term is usually uncertain, and especially so right now. But the prospects of these and other companies remain solid.

The End of Interest Rate Risk

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Larry Hirshik is both a good friend of mine and our talented trader at SL Advisors. We’ve been friends for over 25 years. Larry and I both spent many years trading interest rate derivatives – eurodollar futures, interest rate swaps and government securities. Interest rate risk has been a topic that consumed much of our intellectual energy for close to three decades. Analyzing economic data, extrapolating growth prospects and assessing the likely path of the Federal Funds rate and interest rates in general was an important part of what we did.

So my friend Larry, who often possesses market insight, noted that there is no longer interest rate risk. Every fixed income analyst is really a credit analyst. As I considered this slap at orthodoxy, I realized Larry was on to something. The Fed has promised zero interest rates through at least 2013, and keeps coming up with new, innovative ways to lower bond yields. Almost every developed country has a policy designed to keep bond yields low enough to shoo away all but the least discriminating investor. The dominant issue affecting the cost of credit for almost the entire world is now its own creditworthiness. European sovereign debt yields are approaching or have already crossed high yield. And so it comes to this – 10 year Italian government bond yields, over 6%, are now competing with si,ilarly yielding leveraged loans. Given the choice between a portfolio of senior debt from non-investment grade corporations, or government debt from an issuer whose yields are now so far above nominal GDP growth as to ensure its debt load is unsustainable, investing in the former seems a wholly more sensible idea. Add this to the “Strange World” list.

Thirty Years of Hurt

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It’s not just the last decade that’s been harsh on stocks. A report from Jim Bianco’s eponymous research company calculates that for the past thirty years treasury bonds have outperformed stocks. It’s the first thirty year period since 1861 that this has happened according to research on the topic by Jeremy Siegel.

What could be safer than to bet on a continuation of a thirty year trend? Most of the people working on Wall Street have lived the majority of their careers during a time when safe, stodgy investments have been the place to be – though it should be added that the relatively long duration of thirty year bonds makes their price moves more perky than shorter maturities. But the very success of bond investing makes it that much harder to repeat the performance. Just as stocks had impossibly high P/E ratios in the late 90s as the internet bubble climaxed, ten-year treasury notes yielding 2.2% can only return 2.2% over the next ten years. Thirty year bonds returned 11.5% over the past thirty – the yield on thirty year bonds thirty years ago was 14.68% (according to the Federal Reserve’s H-15 report) which accounts for their subsequent return. Today’s thirty year bond yields 3.25%. As mysterious as is the Math of fixed income to some, even Bernie Madoff couldn’t conjure up past returns out of today’s yields.

No doubt for some time to come bonds will be the beneficiary of investors. The world remains a financially risky place, and the latest EU crisis measures increasingly appear to be short of what’s needed. Wilbur Ross was on CNBC this morning noting that a 50% writedown in all EU peripheral sovereign debt (i.e. the GIPSI countries) would require an additional €400BN in bank capital compared with the EBA’s current stress-test estimate of €100BN (of which €30BN is for Greek banks). Other analysts are increasingly finding fault with the absence of detail in the plan. There continues to be plenty for investors to worry about. And yet, stocks don’t require much dividend growth to outdeliver bonds. $20 in 2% yielding stocks with 4% growth provides the same return as $100 in 2% yielding ten year treasuries, leaving $80 to be held in cash or invested elsewhere. Stocks have had a great October and cheaper entry will be available. But the math is compelling.

There have been many times when the ultimate high in the bond market could have occurred – however, one can be certain that past performance will not predict future returns. One can be reasonably sure that future returns will be very low single digits. And there’s a decent chance that today’s bond investors will lose money. Safety comes with a price.

Another Problem with Low Rates

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The Federal Reserve’s wealth transfer strategy of shifting purchasing power from savers to borrowers has other unintended consequences apart from plundering the thrifty in favor of the profligate. If you run a fixed income fund, ten-year treasury notes with a 2% handle doesn’t create much raw material from which to manufacture some income for your clients. The inadequacy of the yields jumps out, and many thoughtful bond managers have been drawn, or even forced, to reject such poor compensation and to adjust their positions in anticipation of fairer, higher yields.

Thus has the Pimco Total Return Institutional Fund (PTTRX) missed this year’s rally in bonds. Having concluded earlier in the year that U.S. treasury yields offered scant return for the risk, they shunned them publicly and completely through the debt ceiling crisis and into the most recent bout of risk reduction in the third quarter. It was a completely reasonable view to take – they may not have drawn comfort from the fact that we shared their outlook, but we did and so this article is not about bragging that we outperformed Bill Gross. Pimco’s long track record speaks for itself. The point here is that artificially low yields perhaps added urgency to the quest for better fixed income outcomes than were on offer for a passive investor. Positive real yields of, say, 2% (which would require interest rates 1-2% higher) at least afford the plausible option of passively investing and taking what’s on offer. But since today’s yields reduce purchasing power after taxes and inflation, any red-blooded bond manager is virtually required to shop around for alternatives. For a bond fund as big as PTTRX the bets are necessarily big. Their boycott of the U.S. treasury market caused them to miss a fall in yields from simply ruinous to ridiculous.

Just because a view has been wrong is not sufficient reason to change it. That statement doesn’t apply to traders with leverage, since holding one’s convictions too strongly can lead to bankruptcy. But for the unleveraged, new information is the only thing that’s really important. Bond yields have fallen this year and being underinvested has been wrong – so far. But the new bond yields are less attractive than the old ones, and while economic growth has moderated in recent months  the long-term outlook is scarcely that much worse than in the Spring. Active government involvement in the bond market is designed to drive other investors away. Ben Bernanke could as easily hold up a sign during his regular testimonies before Congress saying, “Savers, We Don’t Want Your Money”. What can be more eloquent than the active competition of the government with private savers for its own debt? How loudly should the message be broadcast? If the government wants bonds that badly, let them take the lot. Go elsewhere – senior loans, Master Limited Partnerships, dividend-paying stocks. The government wants savers to consider such alternatives, and will continue to drive them out with derisory yields until they get the joke.

Meanwhile, Bill Gross wrote a rare mea culpa. Well put, and you’ll find no criticism of his past actions here. Pimco have more recently completely switched gears on treasuries and now own them – in fact, if anything based on the aforementioned letter Pimco’s economic outlook is more negative than consensus. Retaining the mental flexibility to move 180 degrees from bearish to bullish is extraordinarily difficult. Most people can only manage moving back to neutral, so kudos to Bill Gross for not letting a few dropped fly balls cause him to lose his nerve. I can’t claim such dexterity – or more accurately, I continue to believe far better alternatives to bonds exist.

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