Weekend: The Bond King Says Sell

Welcome to the Wealth Daily Weekend Edition — our insights from the week in investing and links to our most-read Wealth Daily and sister publication articles.

That’s why it is instructive to keep an eye on so-called “smart-money” — especially when one of them heads for the hills.

That’s exactly what happened earlier this week when Bill Gross — otherwise known as The Bond King — packed up his bags and left Treasuryville in the dust.

In fact we learned that Gross is so bearish now on U.S. Treasuries that his PIMCO Total Return Fund had actually sold every single one of them, completing a giant move out of Treasuries that began last June.

For investors, that potentially spells trouble...

Gross is undoubtedly one of the most connected investors of all time — especially when it comes to the Federal Reserve.

That’s why even though he's a Dukie, Bill Gross is still one of my favorite financial observers.

I find that Bill’s insights are usually spot-on, particularly regarding the big picture. So when he puts out his monthly missive, it tends to be widely read.

What has Gross so worried these days is something that he has actually been talking about for some time now...

The current quantitative easing regime, Gross has said, "is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme."

What's more, he rightfully claims: "It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up."

That is the ultimate gist of his latest letter as Gross ponders the end of QE2, wondering: Who will buy Treasuries when the Fed doesn’t?

The answer, of course, is self-evident.

In the absence of QE3, bond yields would move strongly to the upside as the buyer of last resort fails to pick up the slack.

In fact according to Gross, “What I would point out is that Treasury yields are perhaps 150 basis points or 1½% too low when viewed on a historical context and when compared with expected nominal GDP growth of 5%.”

If Gross is correct, that would push yields on 10-year notes to 5%, ending the bond bull market and perhaps collapsing the bond bubble entirely.

Of course, it is important to remember that bond prices trade inversely to their yields...

So when bond yields scream higher, prices drop — which is why Gross has bailed out on Uncle Sam and boosted the cash position of his portfolio to 23% compared to just 5% in January.

Is the bond bubble about to burst?

So when does Gross expect the rubber to hit the road on this one?

He writes that June 30th could be "D-Day" for the Treasury market...

"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.”

That prospect leaves Gross erring on the side of caution these days as the current bull market reaches its second birthday.

For like-minded investors, that leaves you a few options if you want to follow in the footsteps of The Bond King himself on this trade:

• Either you can short an exchange traded fund like the iShares Lehman 20+ Year Treas Bond (NYSE: TLT)…
• Or you could go long its inverse, the UltraShort Lehman 20+ Trsy ProShares (NYSE: TBT). It is an exchange-traded fund that goes up when bond prices go down.

As for whether or not the current bull market will live to see its third birthday, statistics show that the returns during the third year of a bull market run tend to be on the lackluster side.

According to the data, the average gain in the third year of a bull market is 3.9%, compared to 46% in the first year and 12.6% in the second.

That would leave the Dow at 12,043 by year’s end... not far from where we are today.

Maybe that’s why guys like Bill Gross are keeping their powder dry at this point in the cycle, waiting for a better entry point.

For ways to play the pullback, our editors have put together a few of their best ideas for the years to come in our daily Wealth Daily and Energy & Capital articles, below.

Your bargain-hunting analyst,

Steve Christ
Editor, Wealth Daily

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