The PIMCO Treasury Sale Conundrum…Or Is It?
03/11/2011
By now everyone knows that Bill Gross/PIMCO has sold down his/its Treasury exposure to zero. Rather than ask “why,” quite frankly, my question has been “why did it take so long?” In other words, anyone who knows anything about the bond market knows that it would be sheer stupidity to own Treasury bonds in a rising interest rate, inflationary and dollar devaluation environment. Furthermore, there’s way too many “analysts” out there reading way too much into the decision. And speculation that Gross has some kind of insight into whether or not the Fed will move onto QE3 is absurd. I even laughed at the letter from the former PIMCO employee posted on zerohedge.com explaining how serious and complicated this decision was. That commentary was grandiosity at its epitome. Again, as a total rate of return fund manager and a former junk bond trader in The Show on Wall Street, the decision to own a big position or to not own a particular position is nothing more than making a decision as to whether or not that position has better return/risk potential vs. every other alternative or vs. holding just cash.
Please keep in mind that the flagship PIMCO fund is a “total rate of return” fund, which means that the objective is to maximize return and minimize risk in the context of managing fixed income investment risk. In order to achieve the first objective, total rate of return, it requires having concentrated positions – i.e. big bets – vs. having a highly diversified portfolio. I’ve never believed in having diversified holdings unless you just want to achieve average returns, and below average after all the fund managers and brokers take their cut. Diversification does nothing more than diversify away total rate of return and any potential to outperform.
Any fund manager who manages for return will “tilt” – or overweight – his holdings at any given time within the context of the asset class objective of the fund. Over time, Gross will shift the weightings in his fund largely between mortgages and Treasuries, overweighting one vs. the other depending on his market view.
With that in mind, let’s look at why Gross might have – or more like “likely has” - unloaded all of his Treasuries. Reasons 1-10 have to do with his view of the total rate of return potential of holding a big Treasury position. And this is why I was wondering why it took so long for him to dump everything. With rates where they are, the probabilty that rates will go lower are close to zero. This interest rate cycle has been in place since like 1990 or so. In a historical context, not only is the bull market in bonds (i.e. rates going lower) not only over, the probability is very high that interest rates are going to start moving a lot higher. This is pure cyanide for fixed income securities, since the price of a bond goes lower when interest rates rise. Even if you have a high coupon bond, the total rate of return for a bond in a rising rate environment is going to be negative. I would suggest that this simple determination was the primary reason Gross unloaded all of his Treasuries.
To me this is a very obvious decision because clearly inflation is accelerating and with the Fed spending 100′s of billions to buy Treasuries, interest rates can not be held down – period. Why own any bond in this context? So the only sure thing we know about Gross’ decision is that he thinks interest rates/inflation are headed higher. Doesn’t take a rocket scientist to conclude that. Only an idiot would hold Treasuries in that case.
I read with amusement on clusterstock.com that Gross is making a bet on a huge rally in the dollar because he’s holding so much cash. That view is retarded. Right now I’m sure Gross is just happy to have maneuvered a big Treasury position to zero without the market knowing until it was disclosed and now he will take time to decide how to redeploy the cash in order to maximize return and minimize risk. Gross has actually publicly stated that he thinks the dollar is going a lot lower. Again, rocket science is not required to figure that out. So, if the dollar goes lower and inflation moves higher, that’s a double-whammy for holding Treasuries vs. holding just cash (although holding dollars is not good either lol). But at least in that context, cash will outperform Treasuries since the price of Treasuries goes lower and you get less cash for them if you have to sell them before maturity vs. just holding cash now. Everyone got that concept? If not, think about owing a car that just sits in your garage vs. owning a car that you drive hard everyday. Time value will decay the value of the car that just sits, but time plus hard road usage will act on the car the same way higher rates and dollar devaluation acts on Treasuries.
Finally, QE3. Let’s keep this one simple. I’m sure Gross has his view on whether or not QE3 will happen. But to think that just because Greenspan is a paid advisor to PIMCO gives Gross special insight to the Fed is ridiculous. Greenspan has proved to be a senile old man now with less than half a brain. Not that he had much of a brain as Fed Chairman, but he’s gone off the deep-end in his old age. Regarding whether or not QE is to be or not to be, answer me this: if PIMCO and the Chinese are not buying the 100′s of billions in new Treasuries that will be issued this year, and if the Fed stops buying them, then who the hell will buy all this new paper? Seriously. The Fed HAS to keep printing and buying Treasuries or our Government/system will financially collapse. It’s absurd to think that the Government will let this happen as long as it has the ability to keep printing paper. So unless Bill Gross has some kind of insight into a conspiracy to let the our system collapse, I doubt he has any doubt about whether or not QE3 will occur. And more QE will hasten the devaluation of the dollar and accelerate inflation, thereby completely hammering bond prices – bonds of all flavors and credit risks. So the Gross/PIMCO decision again circles back to the binomial decision of “rates higher or rates lower?”
Again, to make a big bet on fixed income securities is nothing more complicated than deciding whether or not interest rates will be go higher or lower, especially since default risk with Treasuries is not in play for the reason I just gave (we will not include the complication of debating wether or not a determined, motivated currency devaluation constitutes a “de facto” default in order to keep this discussion focused on the binomial decision process of owning or not owning Treasuries). In fact, right about now I bet Gross is wishing that he had the abilty to buy a lot of physical gold and silver for his fund, because in this environment gold and silver will continue to provide the best total rate of return of any asset class. And I bet Gross also wished that mining companies were not throwing off so much cash flow right now and that they had to issue a lot of bonds in which he could throw that cash hoard into…
