Even though he’s a billionaire, mutual fund investing icon and PIMCO leader Bill Gross has been unhappy lately – that is, about the bond market. He is especially grumpy about U.S. Treasuries. And he’s not alone. Even Berkshire Hathaway (NYSE: BRK.A) helmsman Warren Buffett is dour on bonds.
But as for Gross, he’s is a bond guru. Of course, he manages the world’s largest fixed-income fund: The PIMCO Total Return (MUTF: PTTAX) bond mutual fund. It has a whopping $237 billion in assets.
However, there are several other top bond investors who actually think there are some nice opportunities in U.S. Treasuries and Treasury Bonds. One notable manager is Jeffrey Gundlach. He operates the DoubleLine Total Return Bond (MUTF: DBLTX), which has $6 billion in assets.
So who’s right? Well, let’s first get the thinking of Gross. His biggest fear is the huge US debt. But he is not looking at the reported liabilities. Instead, Gross has estimated the accrued obligations – such as for Social Security, Medicare and Medicaid. Because of the aging of the Baby Boomers, he believes the U.S. has a debt of $75 trillion. This comes to about 5 times the gross domestic product (GDP).
To pay this off, the US will have to hike tax rates to onerous levels and substantially cut back on expenses. But is this politically viable? As seen with the protests in places like Wisconsin, the answer seems to be “no.”
The result is that inflation will probably be the cure. If so, bond rates will need to rise to account for the devaluation of the dollar.
Gross also has short-term concerns. Next month, the U.S. government will need to deal with the decision to increase the national debt limit. But in light of the recent budget impasse – which nearly resulted in the shutdown of the government – this could be dicey. Oh, and by late June, the Federal Reserve is expected to discontinue its $600 billion QE2 program to buy US government bonds. Who will take up the slack?
It’s grim stuff. But it’s also based on reasonable economic analysis. To make money from things, Gross has actually shorted $7.1 billion in U.S. Treasuries (this means he will make money if the prices fall). He also has about a third of the portfolio in cash. Although, he sees value in bonds in emerging markets and corporates.
OK, what about Gundlach? Interestingly enough, he’s not an optimist either. He believes that the ending of QE2 will be a drag on the economy. But there are other headwinds like rising commodities prices – especially oil – as well as budget cutting on Capitol Hill. In other words, the US is headed for more austerity.
For Gundlach, this means the GDP will slow down and bond prices will perk-up. He even thinks that bonds will outpace equities for the rest of the year. That’s certainly a gutsy call, especially in light of the bullishness for US stocks.
To make money in this environment, Gundlach realizes he needs to be creative. For his fund, he invests in many exotic bonds, such as mortgage securities. He is also not afraid to invest in risky offerings.
So yes, when looking at both Gross and Gundlach, it’s not easy to get a sense of where the bond market is headed. The disagreement between the two managers is an indication that the markets are at a crossroads. Then again, that’s where lots of money can be made.
It also highlights the importance of diversification across asset types and even countries. Even having a decent amount of cash on the sidelines is not a bad idea. If there is a break in the stock or bond markets, an investor can be ready to capitalize on the better values.
Tom Taulli’s latest book is “All About Short Selling” and his Twitter account is @ttaulli. He does not own a position in any of the stocks named here.
