Bill Gross on the Bond Bubble

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Investors have been trying to decode Bill Gross' pun-filled missives for more clues on why PIMCO, the bond powerhouse he runs, recently abandoned Treasury bonds.

That isn't as crazy as it sounds. Logic tells you that yields are bound to rise (meaning Treasury prices fall) when the largest buyers of Treasury bonds leaves town next month as the Federal Reserve's QE2 program comes to an end. But history says otherwise. It's the opposite of conventional wisdom: Yields fell when the first round of QE ended last year. They rose when QE2 resumed last summer.

Why? One explanation is that the QE programs were smaller than the amount of private Treasury buyers they displaced. So if QE2 was $600 billion, but it chased away $800 billion in private Treasury buyers, the net impact was less Treasury demand. When QE2 ends next month, those $800 billion of Treasury buyers could return, pushing rates back down.

At least that's the theory, and one that's made some question Gross' decisions to abandon the Treasury market.

He cleared things up this morning with a simple Tweet: "End of QE2 may or may not lead to higher yields, but what is clear is that a 1.79% 5 yr offers a negative real yield after inflation."

That's really the meat of the bond bubble. It's not that Treasuries are going to lose value in the coming months -- they could very well rally from here -- but you're still getting a negative return after inflation. Any investment returning less than that 3% annual clip the Consumer Price Index is growing by leaves you in the red.

Where might your money be better off? Several large-cap blue chips still trade at reasonable valuations and have decent dividend yields. A few names: Eli Lilly (NYSE: LLY  ) , Southern Co. (NYSE: SO  ) , Kimberly-Clark (NYSE: KMB  ) , and Intel (Nasdaq: INTC  ) . All yield more than 3%, and all will treat you far better than Treasuries.

Fool contributor Morgan Housel owns shares of Southern Co. Follow him on Twitter @TMFHousel. The Fool owns shares of and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Kimberly-Clark, Southern, and Intel, as well as creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (14)

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  • Report this Comment On May 24, 2011, at 5:44 PM, ynotc wrote:


    Your logic and the article are sound.

    My only question has to do with why you are so confident in loaning money to an entity that refuses to face the reality that things must change.

    regardless of your political or philisophical beliefs it is a reality that we must balance our budget or face default on a scale that no one wants to think about.

    Nero continues to fiddle while Rome burns and all the while we talk about yeilds and why we should or should not loan money to the ultimate troubled asset.

    We can talk about tweaking the tax system, as you have advocated, but even if we confiscated all the money from the top 5% of the tax payers we could only fund our budget for a year.

    We must make hard decisions while we have the time. We still have time to make rational choices. Soon, if nothing changes we will have no choice.

    "If you decide not to decide you still have made a choice"

  • Report this Comment On May 24, 2011, at 6:54 PM, aptosjoe wrote:

    It seems we have backed ourselves into a corner. One group has promised not to raise taxes no matter what, while the other has promised not to cut entitlements no matter what. Nor does either group seem willing to compromise.

    Currently neither group has any incentive to modify their position, nor is there a national leader with enough popular support to break the stalemate.

    From an investing viewpoint, there are no safe harbors either. Post WWI Germany comes to mind as an example of what to expect. It's not a nice thought and I wonder which segment of society will be targeted for scapegoating under the pretext of saving our 'way of life'?

  • Report this Comment On May 24, 2011, at 8:42 PM, TigerPack1 wrote:

    I see more and more people coming around, and figuring out the FED's reality is quite a well scripted fiction...

    BEN is working furiously behind the scenes the last 4 weeks trying to create a stock market crash. This is his ONLY chance to save the Dollar, keep Treasury prices low, and allow him to continue PONZI another 6-12 months.

    Let's see if he can pull it off during the summer.

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