While a big drop in stocks and news of rubber bullets and stun-grenades being used on protestors in Qatif, Saudi Arabia garnered the attention of the news media and investors on Thursday, the bigger investment story is the fact that PIMCO, the world’s largest manager of bond funds has “dumped” their U.S. bond holdings in their flagship Total Return Fund. Leading us wondering if the public will ever catch on to what is happening here.
In his latest monthly missive, PIMCO’s Co-CEO, Bill Gross, poses the question: Who will buy U.S. Government Bonds when the Fed stops? Gross’s answer: He simply doesn’t know.
Given the immense size of the debt market, it is almost unfathomable to come up with a situation where there is a shortage buyers for the bonds the U.S. government needs to sell. Leaving one to ponder the age old question: At what price value?
Gross’s point is relatively simple. If there are too many bonds being brought to market by the U.S. Treasury, the yield is bound to rise. And if you own bonds or bond funds, a rising yield environment is definitely not your friend.
In his monthly investment outlook piece entitled, Two-Bits, Four-Bits, Six-Bits a Dollar the PIMCO chief provides a graphic illustration of the problem that was derived from Fed data and PIMCO estimates:
The first pie graph shows who has traditionally bought the government bonds being issued by the Treasury. The graph tells us that Fed has been good for about 10%, foreign governments have traditionally bought 50%, while everybody else in the market picked up the remaining 40%.
The Middle pie chart illustrates who is buying the bonds the government is offering right now: Foreign governments are buying about 30% while the Fed itself is picking the rest – thanks to a little thing called QE2.
What happened to “the rest of us” category of buyers, you ask? Well, with interest rates currently being held down artificially by the FOMC’s QE2 and the program due to expire at the end of June, anybody with any bond market savvy is simply standing aside.
This brings us to the third graph and the key question: Who will buy when the Fed stops buying? Gross’s response is:
”I don’t know. Reserve surplus sovereigns are likely good for their standard 0 billion annually but the banks are now making loans instead of buying Treasuries, and bond funds are not receiving generous inflows like they were as late as November of 2010. Who’s left? Well, let me not go too far. Temporary voids in demand are not exactly a buyers’ strike. Someone will buy them, and we at PIMCO may even be among them. The question really is at what yield and what are the price repercussions if the adjustments are significant.”
The key words in Gross’s response are “what are the price repercussions.” In English, this means, just how low will prices of bonds have to fall in order to interest the buyers that are still out there?
Frankly this is the scary part. We’ve seen what has happened to bond prices in places like Portugal, Ireland, Greece, Italy, and Spain. And during an interview on CNBC Thursday, Gross quickly noted that Spain’s balance sheet is in a heck of a lot better shape than ours.
Given the expectations for prices to fall, Gross and his buddies at PIMCO have decided to exit stage left in terms of their U.S. government bond exposure. Yep, that’s right; the biggest bond fund managers on the planet don’t want anything to do with U.S. Government bonds with maturities longer than about 9 months.
The question at hand then is relatively straightforward. If PIMCO wants no part of government bonds, why should you?
This doesn’t mean that U.S. Treasuries will be bad investments forever, but if Gross thinks prices are going down far enough in order to justify moving billions out of the way, you might want to follow this bond market “whale’s” lead.
And in case you are wondering, PIMCO is moving the assets that were in Government bonds into corporate, cash, and emerging market bonds. Hmmm…
10-Year Bond Yield - Last 5 Years
Source: TopStockPortfolios.com
