A Bond Play
The Smart Profits Report: Issue #266
Tuesday, December 13, 2005
A Bond Play: Now, Something Completely Different
By Karim Rahemtulla
Chairman, Mt. Vernon Research
Every so often, something I see in my research The Volatility Traderme to alert you, even though it is not options related. Especially if there’s an opportunity to make some money…
A few months ago, I wrote to you that Bill Gross, the guru of fixed income investing at Pimco and the country’s largest bond fund manager, was buying shares of Pimco Municipal Funds. Not surprisingly, he - and you - should be up more than 15% on that bond play, including dividends received.
But what is surprising is that interest rates have moved up almost 200 basis points since he began buying, yet he’s made money.
A Rising Interest Rate = A Nice Bond Play?
Normally, in a rising interest rate environment, existing bond portfolios tend to lose value (because newly issued bonds have better coupon rates, therefore decreasing the demand - and value - of existing bonds).
Gross’ belief, and I agree with him, is that the Fed will stop raising rates in a couple of months. This opinion is based on historical rate hikes and the fact that the consumer and housing sector is not as strong as one would believe from the headlines. Already, housing in many parts of the country is losing steam.
Last week, I read that prices in some Boston neighborhoods had seen prices decline by 15% and more - not a soft landing.
What About The Almost Inverted Yield Curve?
Here is some insight from Gross’ notes in his latest investment outlook… Bill Gross thinks lower rates on the longer-term bonds are here to stay.
His argument centers around the flow of funds from countries like China, and the effect that lowered manufacturing costs have on inflation. He says that these factors have actually reduced the yield on bonds by as much as 200 basis points.
Basically, the 10-year bond at 4.6% today is equivalent to 6.6% in the past. So, we are approaching the top-end of the rate cycle, and the next trend, likely to set in a few months from now, will be neutral to easing.
Putting Money Where Your Mouth Is
What I like most about Bill Gross is that he puts his money where his mouth is. He recently purchased 1,000 shares of two Pimco closed-end floating rate funds - PFN and PFL - both listed on the NYSE. To no one’s surprise, both are trading near their lows and yielding close to 8%.
When he was buying the Pimco Municipal Funds, they were near their lows as well, and he managed to put away quite a chunk. It looks like history just might repeat itself.
Good Trading,
Karim
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Today’s Smart Profits Cribsheet
- Bill Gross’ full investment outlook can be found here.
- Today, I mentioned that Bill Gross was picking up shares of Pimco Municipal Bond Funds a few months ago… Read the details here: Smart Profits #201 - What Does Bill Gross Know?
- Check out the Smart Profits Glossary for definitions of terms like "options" or "commodities" found in today’s article.
Related Articles:
- Basic Trading Rules: The Four Rules of All "Smart Money"
- What Does Bill Gross Know?
- Index Options: A Billionaire’s Trading Tool Anyone Can Use
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