This is an interesting one from Bill Gross on financial repression. It goes back to the policies I have called rate easing and permanent zero, where the Fed is practically guaranteeing yields out to three years. Bill Gross sees this and thinks mortgages!
His point: many investors require certainty and that means fixed income regardless of whether the yield is suppressed or not. And again, this is why I have been saying that yields will not necessarily spike anytime soon despite the fact that I believe then to be artificially low. What I think happens instead is it induces a misallocation of investment capital that creates yet to be discovered malinvestment down the line. From an investing standpoint, Treasuries don’t look that attractive when you compare it to dividend paying safe equity investments.
See:
- Coke Raises Dividend for 50th Straight Year | Crossing Wall Street
- Con Ed Strong on the Defensive – Barrons.com
- McDonald’s raises quarterly dividend 15 percent| Reuters
These are easily plays as good as Treasuries. Gross is going into mortgages because he sees a guaranteed floor being set by the Fed. This makes his investment much less risky since it removes almost all of the interest rate risk – and so, as a domestic investor he has to just look at credit risk.
Here’s the copy from Bloomberg Television:
Gross said that investing in "mortgages make sense" as "yields are not going anywhere for the next two or three years."
**MANDATORY CREDIT: BLOOMBERG TELEVISION**
Gross on whether investors should be looking at mortgages:
"Sure. An agency mortgage, even a non-agency mortgage, but let’s stick to agencies and Fannie and Freddie, they yield 1% to 1.5% to 2% more than those similar average life Treasuries. If you have an environment where interest rates will not change, and that is the key. Is Bernanke good to his promise? If they do not change, you would prefer to have a 1.5% higher yield, a 3% to 3.5% yield as opposed to a 2%. I think mortgages makes sense. The extension of risk adding to high-yield is another situation that is similar to the equity argument that I just made. Yes, you get a higher yield, but you are principle at risk. As you get older and more fixed- income oriented then perhaps you want to stick to something safer."
On why PIMCO is announcing a new ETF next week that will mimic the Total Return Fund:
"That is a complicated answer, but technically the fees are the expenses on an annual basis are less on the Total Return Fund that now exists versus the ETF. There will be a slight difference, but of course you don’t pay the all-in retail fees and you could make the argument that it’s a lot cheaper as an alternative. The ETF is limited to the extent it can’t use futures and optional types of securities that have been successful with the Total Return Fund. Basically they will be the same. We are excited to provide the same types of returns for that ETF as we do for the Total Return Fund and allow individual investors to buy it on the New York Stock Exchange. We do not suggest they trade it, but we think they can buy it at 10:30 in the morning, as opposed to the market closing and have a great longer-term performance record."
Gross on whether the economy and investing environment has improved:
"I think they are. We should analyze why. I think that is always difficult, but I think in this case with central banks writing checks in the hundreds of billions, and yes we’re doing that with our Operation Twist, and the ECB is doing that with LTROs, and Japan has stepped it up, and China has been writing checks in terms of increasing their monetary base. There has been a huge flush of money into global markets and ultimately into global economies. You would expect that to happen. That does not mean that is the solution, or the forever solution, but certainly temporarily it has helped to support the economy, and therefore financial markets."
On whether he’s changed his position in U.S. Treasuries:
"I do not think so. It is important to recognize, as we a tried to recognize at PIMCO for the past several quarters and past several years, that there are negative repercussions to writing checks and printing money. It is not just inflationary. To the extent that zero-based money that we have here in the United States, that we’re seeing in the U.K. and close to that in euro land, it begins to reap some unexpected havoc in terms of the real economy as well. Financial institutions like banks and insurance companies start to close branch offices and lay off people simply because the cost of money does not support the prior economic activity that historically has been the example."
On whether Bernanke’s promise to keep low interest rates through 2014 is distorting the bond market:
"I think it does. There is no doubt. It’s something to be reckoned with. You don’t want to fight the Fed, as they say. To the extent that yes, they have conditionally promised to keep interest rates low, in Bernanke’s vernacular that basically means 25 basis points for the next three years or so, then that produces an artificially to interest rates. There is no doubt that real interest rates now certainly from the standpoint of the policy rate and even from the standpoint of five-year tip, for instance, an inflation protected security at a -1.25% relative to historical parameters, that is 1-2%, maybe even 3% lower than they should be. Yes, Treasury yields are artificially suppressed."
On whether he still wants to be in Treasuries:
"You do from the standpoint of recognizing the Fed is good to its promise, and that is something to consider, but if Fed is good to the promise, then interest rates are not going anywhere for the next two-three years, and there is a 3% yield from a longer-term Treasury and 2% yield from intermediate-term Treasuries. Does that represent value? Not really. Certainly the saver and the investors being short-circuited, haircutted, based upon historical terms. If in fact the price of the securities cannot go down very much if the Fed holds to its promise, that is if it keeps interest rates low, then 2% is better than nothing. Put it that way"
On Leon Cooperman telling Bloomberg TV yesterday that the return on bonds is not worth owning them:
"I do not argue against that, and Mr. Cooperman has a decent argument. I just argued that in terms of confiscation of capital. There are several reasons to be cautious, however. One, comparing Treasury yields to corporate stock dividends spans a huge gap of risk. AAA for Treasuries and an implied B AA and lower for subordinated stocks as an investment instruments. Secondly, stocks can go down, too, just like bonds. We certainly saw that in 2008. Third, demographically, boomers prefer certainty as opposed to speculative capital gains, so there’s an element to that."
On why Ford is shifting billions of dollars a year from their equity portfolio into bonds:
"They’re doing that because of the certainty, locking in their liabilities relative to their assets. Even at a low, 2-3% rate. Boomers, from the standpoint of individual investors, are the same way. They’re beginning to get older and require more certainty. Do they find appeal in a Johnson and Johnson at 3.5% dividend yield with growth potential? Sure they do, but they also believe they want that money back, and if there is a 2008-2009 scenario, perhaps they won’t. So there are demographic tradeoffs here that have to be considered."
Source: Bloomberg Television (video https://www.bloomberg.com/video/87025764/)