Here in the U.S., we're often told that America is the "greatest, strongest country in the world" (as Jon Stewart and Stephen Colbert affirm.) So logically, the U.S. dollar must be the strongest currency in the world and U.S. Treasury bonds the greatest investment ever, right? Well, not necessarily.
Or at least, not according to Bill Gross, big-brain-in-chief at PIMCO's Total Return Fund (PTTRX). This week, we learned that PIMCO's flagship fixed-income fund has just finished dumping all of its U.S. Treasuries. In January, the fund had 12% of its assets invested in Treasuries. By February, it held none. Zilch. 0%. Every T-bill it previously owned -- out the window.
Bill Gross? Who's that?
Now, maybe this doesn't worry you. So some guy is selling a bunch of bonds. So what? But this isn't just "some guy" we're talking about. According to Morningstar, Bill Gross is the "fund manager of the decade" in fixed income trading. His Total Return Fund is 5-star rated and has outperformed his competitors over the past 15 years, the past 10 years, three years, one year -- heck, name a time period and chances are, Bill Gross is sitting top o' the heap.
In short, one of the smartest bond investors out there wants nothing to do with U.S. Treasuries. Why not? And what does this mean to you?
Theory No. 1
To my way of thinking, Gross's decision to dump U.S. debt may have any of three "big picture" implications for little investors like you and me. The first: He may believe the U.S. government is going to default on its debt, and he doesn't want to be holding the bag when it does.
Personally, I think this is the least likely scenario. For one thing, Gross is on record discounting even the risk of widespread municipal defaults in the U.S. Logically, a default by the federal government should be categorically verboten. A U.S. debt default would devastate the global economy, and coming on the heels of the Treasury's massive debt-issuance spree of recent years, a default today would be the height of arrogance.
Theory No. 2
But if Gross isn't running away from a U.S. default, perhaps he's running toward something? Cashing out Treasuries in order to deploy the money in corporate bonds, for example? That's more likely, but only slightly. High quality corporate issuers (and Gross tends to keep most of his assets in AAA-rated securities) aren't paying a lot for their mufflers these days. Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM) recently made headlines scoring interest rates of below 1% on three-year bond issuances. Johnson & Johnson (NYSE: JNJ) managed to sell longer-dated paper paying less than 3%. Both these numbers are currently below the yields on 3-year and 10-year treasuries, respectively.
Theory No. 3
Which brings us to the third, and in my view the most likely, alternative. What's behind Door No. 3? A simple, well-founded belief that the government will be paying higher interest on bonds that it issues "tomorrow" than it's able to get away with "today."
This is the theory that best aligns with the facts. We know that the Fed is approaching the tail end of its latest $600 billion experiment in quantitative easing. By buying up mortgage-backed assets, "QE2" as it's known, has tended to keep Treasury yields "artificially low." Once it ends, rates should rise.
So it's not surprising to see that most of the investments Gross has liquidated from his mortgage-backed securities and T-bill portfolios have been converted to cash, which now accounts for 23% of PIMCO's assets. My guess is that Gross is storing up ammunition to reinvest that cash on "something else" once rates rise. Gross believes that after QE2 reaches port, Treasuries will need to pay roughly 150 basis points more than they currently do in order to attract new buyers.
What's it mean to investors?
If you invest in bonds, the obvious play is to imitate the smartest bond investor on the planet: Shed Treasuries now, and don't buy more till rates rise. But if you are like most visitors to Fool.com -- more interested in stocks than bonds -- there's a lesson here for you, too:
Gross believes interest rates on government debt will rise. Because government debt competes with corporate debt for bond investors' money, corporations will also soon need to pay higher interest rates to raise cash. For corporations such as the famously flush Apple (Nasdaq: AAPL), that shouldn't pose a problem -- you've got all the cash you need, and more is flowing through the door every day.
The situation is more serious, however, for companies like heavily indebted supermarket chain SUPERVALU (NYSE: SVU), which will need to pay more to roll over their billions in net debt. It gets downright dire if you're somebody like trucker YRC Worldwide (Nasdaq: YRCW), carrying a massive debt load, and -- unlike SUPERVALU-- not bringing in the kind of free cash flow you need to service it.
Foolish takeaway
My advice: Holding a lot of cash is not without risk. The amount of money the Fed has been printing these past few years imperils the value of cash, as it may spur inflation. But in a world of rising debt costs, it's probably better to have that problem than ... the alternative. Cash is still king.
