Bill Gross, the founder of Pimco, is the godfather of savvy bond investors and, if you’re looking for a good bond fund Pimco should be on your list. He wrote a thought provoking piece in the May 28th issue of FORTUNE: How to Sleep Well at Night. Bill says that bonds are less volatile than stocks, provide a higher and steadier source of income, and allow you to sleep better at night. (That’s true, although I’m going to argue in coming weeks that good performing dividend paying stocks will provide a higher level of income than bonds over time, but that’s another story.)
Bill admits U.S. Treasuries, which are currently yielding under 5%, may be 50 basis points (.5%) overvalued. He also acknowledges that you can get just as good returns at the bank (I’d say in money market funds).
Why buy bonds? International recycling of dollars will drive yields lower, says Bill. Demand will drive up the price. Wow! The more we buy overseas, the more money foreigners will invest in U.S. Treasures. We should all go out and buy Japanese and German SUVs and use them for our daily commute. Maybe buy some French wine and a new Korean made stereo system while we’re at it. The more we spend on foreign goods, the greater the demand for U.S. Treasuries. (By the way, if Treasures have lower yields that’s good for the stock market, too! Part of the stock value equation is the Treasury yield plus an imputed risk, or rate of return, so if Treasury yields decline, the required return for stocks declines and the stock market goes up.)
Sounds too good to be true, Bill. It seems to me that supply and demand works the other way. The more dollars foreigners hold, the higher return they’ll demand to hold even more dollars/Treasury bonds. I also worry that perhaps a government, such as China, might hold all those Treasuries over our head at some point seeking something in return. (I’m happy to be financially independent of my parents, I don’t want to become financially dependent on China.)
If Bill’s right that long term Treasuries are overvalued (who am I to argue with him?) and if I’m right about how supply and demand works, you might be right to hold only short term bond funds.
