PIMCO Tells Investors To Take Advantage Of Tight Credit Spreads And Sell

Tyler Durden's picture

Following up on Paul McCulley somewhat disingenous piece we discussed earlier, the Fashion Island bond guys are out with another report, this time by Managing Director Mark Kiesel, who basically is saying it is time to "Sell, Mortimer."


Strong growth in emerging
markets (EM), the inventory cycle and accommodative fiscal and monetary
policy continue to support the global economy. However, the handoff
from the public sector to the private sector in most developed
countries is likely to be weak due to a lack of animal spirits
exhibited by businesses as well as consumers, high and growing
sovereign debt burdens and ongoing deleveraging in the private sector
(Chart 1). The U.S. economy’s recent growth has been underpinned
significantly by government policy, yet this short-term cyclical
support will likely fade in the second half of 2010. As a result,
investors should take advantage of the tighter credit spreads and focus
on de-risking
their portfolios in order to prepare for the increasing
long-term secular headwinds stemming from the growing deterioration in
public sector balance sheets in many developed economies.

Pimco's distrust of the new normal is nothing new.

Corporate capital spending and
hiring remain weak as firms continue to focus on cost cutting,
repairing balance sheets and deleveraging. Consumer spending in most
developed countries continues to be depressed by weak labor markets,
poor income growth, low savings, high debt, the potential for an
increasing tax burden and tight credit availability. While prices for
low-end U.S. housing have recovered somewhat, most of the improvement
has been driven by the government’s homebuyer tax credit. The
government’s “cash for clunkers” stimulus program is over, and there
appears to be only limited pent-up demand for autos in its absence. Simply put, private sector demand remains weak and public
sector support is set to fade.

The biggest threat to capital markets everywhere is the gradual (or sudden) withdrawal of liquidity. On this point Kiesel seems to contradict his superior McCulley in a variety of ways, mainly in that he expects Central Banks to act prudently and rationally.

Further, public sector debt has
now increased to a level that will require fiscal tightening in most
developed countries. State and local government spending is also likely
to be reduced. In addition, monetary policy is likely to become less
accommodative globally as central banks unwind unconventional liquidity
programs put in place during the crisis and  gradually raise interest
rates. Nevertheless, central banks in countries with high consumer and
growing government debt burdens will likely continue to inflate,
leading to steep yield curves, in particular in the U.S. and the U.K.
The effectiveness of fiscal and monetary policy should remain limited
in these economies due to the continuing deleveraging in the private
sector, a weak multiplier effect and constrained bank lending (Chart

As we touched upon a week ago, a rather relevant topic that has been untouched for now, is the increase in equityholder-friendly actions in corporate capital structures, which will ultimately be credit negative.

However, there are a number of
risks facing the corporate bond market, including defaults,
increasingly shareholder-friendly corporate actions and the potential
for rising government and municipal issuance to “crowd out” capital and
raise corporate borrowing costs. With U.S. economic growth likely to
fade in the second half of 2010 and below-trend economic growth likely
in 2011, corporate default rates should be elevated over our secular
horizon (Chart 4). This argues for investments that are senior in the
capital structure and a focus on bonds in companies with strong asset
coverage and low leverage.

Investors also need to be wary
of the pendulum swinging from bondholders toward equity holders if
rising corporate cash balances are diverted to equity holders through
increased dividends or share buybacks (Chart 5). In addition, capital
spending could pick up given the divergence between capital
expenditures and corporate cash flow (Chart 6). This argues for careful
credit selection within industries that have the incentive to maintain
bondholder-friendly policies.

The cautious conclusion which leads to the earlier observation that it may be time to get out of credits:

While rising public sector debt
levels have not yet led to materially higher interest rates, rising
demand for credit in the private sector could lead to higher risk
premiums as the global marketplace struggles to support large and
growing government financing needs. Finally, governments in some
countries may choose to raise corporate tax rates in order to reduce
growing sovereign budget deficits. All these risks argue for
extraordinary discipline in evaluating credit investments.

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Ned Zeppelin's picture

Rates go up, bonds go down.  How hard is this? Freaking genius. Why would rates go up, even as there are no inflationary pressures from the moribund private sector? The ever-increasing debt of the sovereigns, which has to be issued and has to be rolled.  Equities? Rally is based solely on QE and stimulus.  Say night-night.

doublethink's picture


The "Great Firewall of China" does not block PIMCO does it?


BlackBeard's picture

Plebe frantically pushing green button: Must...keep....indices in the green.......

buzzsaw99's picture

Wasn't he saying "buy" just yesterday?

Orly's picture

He said buy foreign corporates, especially emerging markets, but stay out of USTs.

casino capitalism's picture

What I would like to know is why can't government bond yields trade higher than high quality corporate bonds?  Governments are rapidly heading to fiscal crisis but a lot of high quality corporate balance sheets are in great shape.

A Man without Qualities's picture

Lots of high quality corporate balance sheets are only in great shape if you assume that asset values are stable.  The deflationary effect of higher sovereign yields may make this assumption break.


asteroids's picture

If you were a CEO/CFO and just dumped all your shares because you saw a fiscal hurricane coming. Wouldn't you raise cash hoping to ride it out?

jm's picture

Also, the sovereign in which said better credit is domiciled can raise taxes on said credit until its quality is... rather flacid. 

rubearish10's picture

PIMCO talks way too much. They (Buffet, Rogers & Faber ETAL) should all just shut up and stop either talking up their books or working the other side of the trade. This is getting stupid. How about some sound research and facts like TD & Co. usually delivers?

Leo Kolivakis's picture

Why do you all take PIMPco's advice so seriously? By now, they should just come out and say "Sell so we can buy some more". Spreads are going to come in more as stocks surge forward.

Ned Zeppelin's picture

A very bullish bet, and I understand your reasons, just not sure about it for the exact reason stated above: climbing sovereign rates have deflationary effect that sooner or later will catch up, + QE ending.   Why would sovereign rates stay low?

aus_punter's picture

care to stand by that prediction oh wise one ? Any levels or targets or is this just an off the cuff ?

Madcow's picture

As the keg starts to bubble and foam and run dry, those last 3 or 4 cups of beer are going to be expensive.  

Then the keg floats and the party is over.

Oh well ...

dark pools of soros's picture

we need a computer virus at JPM so one day silver can go ape shit and then see how the rest of the cards hold up


and by 'ape shit' I am saying from $16 to $350 in a day

monopoly's picture

Most of us all agree on the outcome guys. As always, just the timing and we all know markets can stay irrational a lot longer than we can imagine. If we get the timing close Mr. and Mrs. bear and their gold trinkets will have a field day that will last a long, long time.

Being patient and adding to physical gold on a regular basis. Not a bad close today all.

And as always Tyler and gang. Thank You.

trav7777's picture

If these guys think that the debt bondage the public has been sold into is going to sit well, look at Iceland.

I mean, jfc, has anybody thought through the pain of actually paying all this sovereign debt back to bankers that never ACTUALLY had the money in the first place plus interest is going to cause?

At the same time, cut public sector spending to the bone, eliminate socialist entitlements that were paid into for a lifetime, and the people will just eat it and smile?

Fuck that...default will come.  I mean, we are talking Irish Famine level taxes needed here.

The Fed created the money to lend out, and it's due back with interest - fuck that.  Less spending, more taxes...people are not going to live being crushed like that

dark pools of soros's picture

people hate math... even engineers so way too many people are just blind to the cause of their pain

especially ones who don't own a house - but anyway..  I find it really telling that the BK rules were changed way in advance to a lot of this BS


"luckily" I crashed and burned early during the dot com days and was part of the last wave of the old BK ways...  everyone would be taking that mulligan these days which would keep the banks in check.. they wouldn't try to be loan sharks without the new BK lockdown

hooligan2009's picture

The Fed has been helping the Treasury debase the currency as a panacea to their friends failed attempts to deliver the American Dream on the back of borrowed money that can never be repaid and only gets bigger. The Federal Rserve system has failed (if it ever worked) and needs replacing. Ponzi scheme democracy also has failed and needs replacing, possibly because after certain tipping points, no political system will only deliver negative economic rents and "social" goods.

I am left with the words of someone who has a lot of money (PIMCO is a corporate trillion dollar man, compared to the Fed as several trillion dollar man and the Treasury as milti-trillion dollar man) but delivers no value.

What is the point of investing in any bond within a regulated (either communist or rigged like the Fed) maket when the outcome is that value is not preserved or delivered.

Intuitively the purpoe of a bond is a low risk option to delivering a series of cash flows that can replace work to fund a lifestyle, health or retirement from work. If the world is full of bonds, as now, then no-one has to work. The problem we have is that the money machine has largely grown to its current size because there simply is not the value being generated. The Treasury has issued promises (pork barrel democracy over decades) worth around $14 trillion with another $25 trillion in medicare/medicaid still to come. This debt is financed based on an assumed tax take. Call it 40 trillion and flip the argument. Instead of saving into bond funds like PIMCO where a share of productive cash flows is invested in emerging markets or high quality credit, we have the promises of no value being drawn on the Governments Ponzi scheme. (See Nathans for debt saturation also). We are short a "value"/draw down rate equivalent to a maximum use of any capital project (20 years) or 5%. So we are short 40 trillion x 5% per annum = $2 trillion.

So here's the rub from our Ponzi democracy (same as Greece's Icelands Russias Chinas Japans et al). You can't create a retirement/health/lifestyle plan by borrowing money, unless you have an an asset that has cash flows. Where the asset is Government debt, then it needs to be repaid at the same rate it is being used up by aging and dying voters. The Government and the corporate sector simply don't have sufficient cash flows to fund the promises that the Government and the Fed is making. It never will and never has.

The Fed can play all the games it likes. Any group of 12 bloggers on this site are as qualified to be Fed Governors as the encumbents. They have no clue, no right and are civil servants/academics who are just guessing. (Otherwise, we would not have democracy we would have central bankracy  - rather than the Central Bankruptcy we currently have).

For me, the new model is a ten year "rebirth" where the accumulated debt is set off against the accumulated worth. So if 40 trillion of debt has been issued/promised and only 25 trillion of value (houses/pensions/lifestyles) exists, then we have lost 15 trillion, should write it off and start with aclean slate. Bugger this permanent Ponzi crap!

I am left with a personal problem. If I have pensions starting in 15 years, worth around $25,000 a year and I have $300,000 in the bank, what should I do with it? I want a life, I want to be healthy and have leisure time startign as soon as possible. Right now..living modestly but doing nothing for 15 years sounds like the best option. My worry is, I must work my butt off to cover the huge leap in the cost of living from Federal taxes and city taxes that are about to take off (within the current screwed up Ponzi democracy and currency debasement of the current Fed/Treasury model.

Any ideas?

jm's picture

This surely is nothing that you don't already know.  I respect what I hear from you, and enjoy talking to you. 

So if 40 trillion of debt has been issued/promised and only 25 trillion of value (houses/pensions/lifestyles) exists, then we have lost 15 trillion

So true.  This means there is less equity than ever anywhere, only recovery value.  So stay at the top of the capital structure.  You can trade recovery value synthetically as things go to crap, but a CDS clearinghouse/ proposed ISDA regs may screw this up soon. 

I can't see much profit potential anywhere, but I know that risk premia in every sense of the term will mean revert.  So defense companies-- the kind that build things which blow stuff up--are safe-ish inome streams. 

Diversification?  There are assets mostly uncorrelated to the economy: CAT bonds.  Lehman was a big player there, so look carefully.   

Finance and risk management will never go away, and if it becomes a soviet instrument, then investing/stored capital doesn't matter anyway.  So make your labor income stem from finance or insurance.  I read LIBID from your comments once, so I think you got that set. 

Bill Gross said something non-talking-the-book once: shake hands with the government.  Get on the right side of the Fed.  Also, Bill clearly has an inside information edge.  Go with people with an information edge. 

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