By Bryan Keogh and Cristina Alesci
July 1 (Bloomberg) -- Investors should favor bonds and dividend-paying equities as the U.S. heads into a “new normal” of higher savings and lower consumption, said Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co.
Higher savings, lower consumption and annual economic growth of about 2 percent, as opposed to 3.5 percent, may last a generation or more, meaning investors should “stress secure income,” Gross, who helps oversee about $756 billion as co- chief investment officer at Newport Beach, California-based Pimco, said today in his July note to clients.
“‘Non Appétit,’ not Bon Appétit, will become the apt description for the American consumer, and significant parts of the global economy, including the U.S,” wrote Gross, whose Total Return Fund ranks in the top 1 percent of similar portfolios in the past five years. “It promises to persist for a generation at a minimum.”
Investment-grade corporate bonds returned 9.2 percent this year through June, beating Treasuries by a record 13.7 percentage points, according to Merrill Lynch & Co. indexes. The U.S. government and the Federal Reserve have pledged more than $12.8 trillion to thaw frozen credit markets in hopes of pulling the economy out of the worst recession since the 1930s.
Consumer spending rose 0.3 percent in May, the first gain in three months, as benefits from the Obama administration’s stimulus plan spurred a jump in American incomes, signaling efforts to revive the economy are starting to pay off. The higher incomes drove the savings rate to a 15-year high.
‘Avoid Retailers’
Investors should stay away from industries hurt by falling consumer spending,Mark Kiesel, global head of corporate bond portfolios at Pimco, said in an interview yesterday.
“I would avoid retailers like the plague,” he said. “It’s not going to be a normal recovery because the consumer is overlevered and because credit is going to flow less freely.”
Investment-grade corporate bonds handed investors 10.8 percent in the three months ended yesterday, the best performance since 1982 when returns including reinvested interest and price appreciation was 17 percent in the third quarter, according to Merrill’s U.S. Corporate Master Index. High-yield, high-risk debt gained a record 23 percent.
Signs the 19-month-old recession is easing led Frankfurt- based Deutsche Bank AG this week to boost its forecast for global economic growth next year to 2.5 percent from 2 percent.
‘Cheapened Up’
Corporate bonds outperformed other investments in the first half because traders were pricing in a “Great Depression” scenario that has been averted, according to Joseph Balestrino, a money manager at Pittsburgh-based Federated Investors Inc., which oversees $409 billion of assets.
The debt “cheapened up to the point where credit was cheap to almost every other asset class,” Kiesel said.
Pimco’s Total Return Fund, with $157 billion of assets, has returned 6.3 percent this year, 9.3 percent over the past 12 months and 6.4 percent annually on average for the past five years, according to data compiled by Bloomberg.
The recent rally in bonds and equities, while fueled by optimism about the economy, may stall and cause more pain for investors because the direction of trends is still negative, said David Hirst, co-head of credit fixed-income at Mitsubishi UFJ Securities in New York.
The U.S. economy shrank at a 5.5 percent annual rate in the first quarter, the Commerce Department said on June 25, adding to a 6.3 percent decline in the prior quarter, the worst six- month performance in half a century.
Doubting Data
“Investors are questioning whether they can trust positive signals that indicate the recession is bottoming,” Hirst said. “People are starting to look at the glass as half empty.”
While bonds will continue to outperform in the second-half of 2009, investors will need to be more selective, with a focus on higher-rated securities issued by banks, utilities, non- cyclical companies, banks and any industry that will benefit from an increase in inflation, Kiesel said.
In the first six months of 2009, a “rising tide lifted all boats,” he said. “The second half of the year is going to be more about picking the winners and picking the losers.”
To contact the reporters on this story: Bryan Keogh in New York atbkeogh4@bloomberg.net; Cristina Alesci in New York atcalesci2@bloomberg.net.
