Bill Gross: US deficit spending and dollar depreciation should have investors fleeing treasuries and running for emerging market credit

Bill Gross of Pimco is emphasizing what everyone should know by now, that even though the yield curve slopes upward, yield curve risk is more dangerous now than credit risk. 

It is quite attractive to borrow treasuries short, lend treasuries long and just keep rolling over short term debt so you make an attractive yield over time.  But it is a fools game right now.  Those who engage in such folly will be eaten for lunch.  Via Pimco:
•American politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion-dollar annual deficit.
•Policy stimulus is focused on maintaining current consumption as opposed to making the United States more competitive in the global marketplace.
•Dollar depreciation will sap the purchasing power of U.S. consumers, as well as the global valuation of dollar denominated assets.

Investment implications

1.An astute mantis-like investor must defer immediate gratification, make a 180˚ turn from that sexy looking female with those long green legs (long term bonds) and mend his ways fast! It is still possible to earn an attractive return from bond strategies (such as PIMCO’s Total Return strategy in 2010), and the way to do it is to focus on “safe spread” that emphasizes credit, as opposed to durational risk.

2.These “safe spreads” include: emerging market corporates and sovereigns with higher initial real interest rates and wider credit spreads; floating as opposed to fixed interest obligations; and importantly currency exposure other than the dollar.

3.For those inclined to lunch on stocks, remember to go where the growth is – developing as opposed to developed markets. If the U.S. must pay an eventual price for mindless deficit spending, then find countries and currencies that appear to have their act under control: Canada, Brazil, and yes even Mexico with its drug related violence. Mexico has a net national savings rate that exceeds our own by 20% of GDP.

4.Above all, remember that all investors should fear the consequences of mindless U.S. deficit spending as far as the mantis eye can see. Higher inflation, a weaker dollar and the eventual loss of America’s AAA sovereign credit rating are the primary consequences. Fear your head – fear your head.


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