Bill Gross – June 2011 Investment Outlook: Buy Cheap Bonds with Safe Spread
Well, much like the Tower of Babel, Treasury bond prices cannot be heaven bound but have more earthly limitations. While stock values are often complicated by growth rate assumptions and P/E ratios making their ultimate destination uncertain, bond yields at least have a mathematical zero bound below which they cannot journey for more than a few nanoseconds. Investors don’t give up their money for the promise of less money in return and so negative nominal yields are a mathematical impossibility aside from fears of government confiscation and temporary liquidity considerations. But here is where it gets tricky and where our soon-to-be-boiled frog comes into play. Much like gradually turning up the temperature on poor froggy’s kettle of water, monetary policy in developed countries has been lowering the temperature and absolute level of yields for the past 2½ years post Lehman Brothers. Teeter-totter yields down, teeter-totter prices up, and froggy’s total return euphoria at present seems to know no bounds. But once the potential for even lower interest rates is minimized by the zero floor, our future frog-legged entrée is left with a rather uncomfortable feeling. He’s resting inertly in this caldron as prices near the boiling point with the Fed, the Chinese and the banks all buying up whatever Treasury bonds are offered. Everything appears well. But bond investors with a survival instinct (being one and the same as our cooking frog) should reflect on that old teeter-totter metaphor and realize that prices near the boiling point automatically imply yields near subzero. Granted, 5-year Treasury rates near 1.70% are not zero and 10s and 30s are even better, but much of the Treasury yield curve now rests in negative territory when compared with expected future inflation, and that should send our bond investor into a hoppin’ funk. Prices are already nearing the boiling point and his coupons are subzero, CPI adjusted. Total return…and our frog…are cooked, or if not they are certainly trapped in a future low return kettle of water.
