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PIMCO’s Bill Gross Says to Sell U.S. Treasuries Now

By Jim Fink on March 3, 2011

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A strong price for oil is bullish for the Canadian dollar and assets priced in that currency. The loonie is firmly above parity with its US counterpart, and factors other than the price of oil conspire to keep it on the climb for the near future.

– Roger Conrad, Canadian Edge

When it comes to fixed-income investing and interest rates, Bill Gross of PIMCO is “the man.” Last December, I wrote that Bill Gross was buying municipal and corporate bond closed-end funds (CEFs) in the face of a mini-bond market crash. Since the December 17th publication date of that article, eight of the ten CEFs he purchased are trading higher. The two losers involved California municipal bonds. As I predicted, the corporate bond funds he purchased have been the best performers. 

Bill Gross’ Bearish Call on U.S. Treasury Bonds

I bring you this update for two reasons. First, it proves once again that Mr. Gross is worth following. He was short-term bullish on municipal and corporate bonds back in December and he was, for the most part, proven right.

Second, he recently released his market commentary for March where he makes another market call that is probably also worth following. To wit, he predicts that when the Fed’s QE2 bond-buying binge ends at the end of June, there will be nobody to take the Fed’s place as last-resort buyer of U.S. Treasuries at artificially low rates. Treasury yields will need to ramp up sharply by 1.5 percentage points to attract private buyers. Given that the ten-year U.S. Treasury is currently yielding only 3.5%, a 1.5 percentage point jump would equal a 43% increase in interest rates (1.5/3.5). That’s a big move in interest-rate land and would have a significantly negative effect on bond prices.

Stock investors, take note: your holdings would also be affected. Remember that stocks are valued based on discounted future cash flow. The interest rate used is typically the ten-year U.S. treasury plus a business risk premium. A higher ten-year U.S. Treasury would cause a company’s future cash flows to be discounted more heavily, resulting in a lower stock valuation. So, higher interest rates would be a negative for all forms of financial assets, not just bonds.

Bill Gross is Selling U.S. Treasuries Now

But for Bill Gross, stocks are an afterthought and his main fear is a decline in bond prices. Gross writes that his firm is selling U.S. Treasuries now and asking questions later:

Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets. PIMCO’s not sticking around to see.

The Chinese own more than $1 trillion worth of U.S. Treasury bonds. That’s a lot of moola at risk for a price decline. I don’t envy China at this point in the interest-rate cycle!

Ben Bernanke Seems to Rule Out QE3 . . .

Of course, if Fed chairman Ben Bernanke and company were to decide that QE2 should be expanded into QE3, all bets would be off. But another bond-buying binge appears remote, especially after Bernanke’s congressional testimony the past two days (March. 1-2). In it, Bernanke states that the “economic outlook has improved, downside risks to the recovery have receded, and the risk of deflation has become negligible.” Since quantitative easing was initiated as a safeguard against deflation, Bernanke’s statement that deflation is no longer a risk says to me that he will not authorize QE3. Yesterday’s (March. 2nd) release of the Fed’s Beige Book supports this conclusion as it showed incipient inflation pressures throughout the economy. Some market pundits have speculated that the severe market selloff on March 1st was based on investors coming to the realization for the first time that QE3 was not going to happen.

Or is Ben Bernanke Leaving the Door Open?

On the other hand, Bernanke didn’t completely rule out QE3 because he also said during congressional Q&A that the Fed “doesn’t want to see the economy fall back into a double dip or to a stall-out.” Deflation is a rare and serious problem that does not occur simply because an economy stalls, so I was surprised and confused to hear Bernanke seemingly expand the conditions under which QE3 could occur.  If an economic stall-out is all that Bernanke would require for QE3 to be triggered, than QE3 might actually occur. Barron’s Magazine interviewed economic forecaster Stephanie Pomboy in this week’s issue and Ms. Pomboy makes a convincing case for why the current economic recovery may not last. She actually recommends buying U.S. Treasuries right now!

Canada to the Rescue!

Only time will tell whether bear Bill Gross or bull Stephanie Pomboy is right concerning the future direction of U.S. Treasury prices. But one thing is clear now: there’s a lot of uncertainty and who needs the stress? You can avoid the whole debate and leave U.S. economic problems behind by investing in Canada. David Dittman, regular contributor to Roger Conrad’s market-beating Canadian Edge investment service, recently wrote:

Canada’s fiscal position is better than all of its G-7 peers, it’s the beneficiary of interest-rate differentials, particularly with the US, that stand to widen substantially, perhaps as early as this spring. The Great White North appears to be an economic oasis.

Canada doesn’t have any of the budgetary or housing-related problems of the U.S. and it pays higher interest rates to boot!  Consequently, buying Canadian stocks seems like a no-brainer.

Canadian Stock Screen

I used by trusty Bloomberg terminal to screen for Canadian companies with the following characteristics:

  • Dividend yield of 5% or greater
  • Market cap of $1 billion or greater
  • Positive cash flow from operations
  • Positive net income
  • Payout ratio of 75% or lower
  • Positive 3-year dividend growth

Five stocks made the cut:

Company

Dividend Yield

North West Company (Toronto: NWF.TO)

6.3%

Riocan REIT (Toronto: REI-UN.TO)

5.7%

BCE (NYSE: BCE)

5.6%

Cineplex Galaxy Income Fund (Toronto: CGX.TO)

5.4%

AGF Management (Toronto: AGF-B.TO)

5.3%

These are not recommendations but just some ideas to vet with further due-diligence research.

U.S. investments may suffer if QE2 expires as scheduled on June 30, 2011. Adding some Canadian stocks to your portfolio as protection may be prudent.

Find the Best Canadian Stocks with the Help of Canadian Edge

If you don’t have time to do your own due diligence, let Roger Conrad do it for you. The editor of the market-beating Canadian Edge investment service has uncovered not only the highest-yielding Canadian stocks, but those with the strongest business fundamentals to sustain their dividends and grow them further.

Put June 30, 2011 on your calendar. Don’t let the end of QE2 damage your portfolio. Let Canada’s economic health work for you. To find out the names of the Canadian high-income stocks Roger likes best right now, give Canadian Edge a try today!

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  1. avatar
    VennData Reply March 10, 2012 at 11:10 AM EST

    The ten-year isn’t yielding anywhere close to 3.5%

    • Jim Fink
      Jim Fink Reply March 10, 2012 at 11:16 AM EST

      I wrote that article a year ago when the ten-year Treasury yield was much higher.

      Jim