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The bond market has gotten something of a shock over the last week, since Ben Bernanke confirmed the Federal Reserve won't keep the punch bowl filled forever and sent the 10-year Treasury yield on a steep climb to 2.55% and its highest levels in more than a year.
Pimco bond guru Bill Gross increased Treasury exposure in the firm's Total Return fund in April, then watched rates rise in May (on remarks made by Bernanke before Congress) and take off in mid-June after the FOMC meeting. Now in his latest investment outlook on the firm's website, Gross is admits the bond ship has taken a few blows, but he still says it isn't going down.
"The U.S. economy is not sinking, nor are the majority of global economies," Gross writes. "Their markets just had too much risk, and in PIMCO’s opinion, too much hope for a constant QE and for the growth that it would produce. In effect, the ship was top heavy with too little ballast."
Read Gross' entire July Investment Outlook here.
The de-risking of late, he argues, simply went further than anticipated, marring Treasuries and stocks in addition to corporate debt trading at narrow spreads and assets in emerging markets. But he's not giving up his conviction so fast.
Gross, tapping his Navy background, urges investors to avoid jumping into the freezing ocean (money market funds that will return next to nothing) and stick with bonds that may not produce the same results they did during a decades-long bull run, but still have room to produce positive returns.
The argument has three main points: the Fed is too sanguine about the economy, focusing on cyclical housing prices and auto sales; inflation remains substantially below the level at which the central bank would feel forced to act; and Treasury yields have backed up too far compared with fed funds futures, which show expectations for a 0.75% fed funds rate in 2015.
In Gross' estimation, Bernanke's comments in May and June were the impetus for a correction to what had been an overbought bond market in late April, a correction that has now become overdone.
So, smooth sailing ahead? Hardly. Gross says to expect 3-5% annualized returns in bonds and stocks for the foreseeable future. Better than nothing, but a welcome result given Pimco Total Return's recent rocky seas, which include its worst monthly loss since the financial crisis in May. The Pimco ETF Trust, an exchange-traded fund that tracks the flagship Total Return Fund, is down more than 4% since Bernanke's May 22 congressional testimony.