PIMCO's El-Erian: Bonds Are Cheap Here
August 26, 2010
We’ve been highlighting the apparent disconnect between the action in the bond and the stock markets for some time now. Loads of analysts suggest that the bond market is “telling” investors to look out below in terms of the economy’s direction. However, we’ve taken the stance that this may not be the case.
We’ve opined that with hedge funds now accounting for 20% of the massive U.S. Treasury market, that government bonds are the new “momentum trade.” And in case you aren’t familiar with this type of trade, think technology in 1999 and Oil in 2008. Thus, we’re of the mind that at least part of the message from the action in the bond market isn’t really a “message” but rather too many dollars chasing too few bonds.
However, we have also been around this game long enough to know that it is absolutely vital to be able to admit when you are wrong. So, when one of the sharpest minds in the bond biz takes an opposing view, we sit up and listen.
On Thursday, PIMCO’s Mohamed El-Erian, who co-manages the world’s largest bond fund told CNBC that bonds are not in a bubble and are actually cheap. Hmmm…
El-Erian said Thursday, "If you look at what the (bond) market is telling you, it's saying that the outlook is for low growth and disinflation… The bond market may be cheap in terms of a slow recovery scenario."
The Co-CEO of PIMCO also said that the rush into buying bonds is due to the fact that many investors are underexposed in the fixed income market— and that people are more risk adverse.
El-Erian and his partner in crime Bill Gross, originated the term “the new normal” last year to describe how PIMCO views the world in this post-crisis era. In short, the bond kings suggest that investors need to accept a different kind investment environment where slower growth and high unemployment sticks around for quite some time.
Viewed from a “new normal” perspective, El-Erian seems to be telling us that bond yields have farther to fall. Without any worry of inflation and perhaps the real threat of deflation, PIMCO’s view is there may be more upside potential in bonds.
This would explain the relentless fall in bond yields seen over the four months and the reason that hedge fund managers appear to be throwing every dollar they can get their hands on into bonds.
Of course, another part of the bond story is fear. More specifically, there is the fear of sovereign debt problems resurfacing in Europe as well as the “unusual uncertainty” relating to the outlook for the U.S. economy. Therefore, investors around the globe continue to pour money into the safest vehicles they can find: U.S. and German bonds.
On the topic of the economy, El-Erian also agrees with Nouriel Roubini’s view that the risk of a double dip is on the rise. El-Erian told CNBC Thursday, "I think Nouriel is correct when he says the 'US has no spare tire' to fix the economy if something happens." Wow, Mohamed El-Erian and Dr. Doom agreeing on something – now that’s interesting.
So, while we’re not willing to say that we’re wrong on the subject, with El-Erian saying that bonds are still cheap given the environment, this remains an area to watch. In short, if bond yields continue to fall, stocks may have more problems to deal with going forward.
iShares Barclays 7-10 Year Treasury Last 12 Months
Remember, you are in control your email alerts! You can receive alerts for up to 25 free research report alerts including:
To Add or Remove email alerts, simply Login to Your Portfolio and click on Email Alerts
S&P 500 Last 5 Years