Buy Early What The Government Buys Later

...future policymakers must confront the reality that is, not the one that should have been. And investors must do likewise, casting aside personal philosophies for a clear-headed view of the future horizon. PIMCO’s view is simple: shake hands with the government; make them your partner by acknowledging that their checkbook represents the largest and most potent source of buying power in 2009 and beyond. Anticipate, then buy what they buy, only do it first: agency-backed mortgages, bank preferred stocks, and senior bank debt; Aaa asset-backed securities such as credit card, student loan, and auto receivables. These have been well-advertised PIMCO strategies over the past 6 months but there are others in clear sight. An Obama administration will quickly be confronted by the need to provide those hundreds of billions of dollars to states and large municipalities. Their requests total nearly a trillion dollars and to think California or NYC would be allowed to fail is, well – unthinkable. Municipal bonds then, selling at historically high ratios relative to U.S. Treasuries, offer attractive price appreciation potential, or at the very least a defensiveness with high carry that a 2½% 10-year Treasury cannot.

Here’s another thought. While TIPS or inflation-protected securities cannot logically be a recipient of Uncle Sam’s checkbook over the next 12 months, they can benefit if and when the government’s efforts to reflate begin to take hold. 2½% real yields cannot possibly be maintained unless deflation as opposed to inflation becomes the odds-on favorite. What bond investors know as “breakeven inflation rates” are currently signaling a future where the U.S. CPI averages -1% for the next 10 years. Possible, but not likely. As an additional strategy, global bond investors should recognize the value in high-quality investment-grade corporate bonds in many markets. Yields of 6%+ for intermediate maturities are still common and readily available.

There is legitimate concern as to the ultimate destination and outcome of our “bailout nation.” Realistically, quantitative easing, a two-trillion-dollar expansion of the Fed’s balance sheet, and the near certainty of future budget deficits approaching 6-7% of GDP should alert bond investors to once again become vigilant as was the case in the 1980s and 90s. Vigilantes we should be, but that is a battle to be fought in the Treasury market where low yields offer little reward and increasing risk. For now, our Ponzi-style economy and its policy remedies encourage bond investors to mimic Uncle Sam and its global compatriots. Buy what they buy, but get there first.