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PIMCO Missed the Trade of the Year in the Treasury Market
By EconMatters
PIMCO who specializes in Bonds, having the largest bond fund in the world could not have been more wrong about an asset class, which is surprising considering their experience in this sector. Bill Gross`s official declaration that his firm was shorting the US Treasury Market on April 11th of this year to the day marked the literal double bottom in price/high in yield for the year, and it has been one heck of a one-way trade in the opposite direction ever since.
Major Move - Trend Traders Dream
On April 11th the 10-Year Treasury was yielding 3.57% and on August 19th it reached a low yield of 2.06% that is a 151 basis point move in a little more than four months. Somebody at PIMCO is going to be receiving the lower end of their discretionary bonus range at the end of the year that`s for sure. But how could they make this mistake in the first place?
"Sell in May, and Go Away" - Pattern Recognition?
We, at EconMatters, used last year as a template and forecast the exact opposite trade around the same time in April as Bill Gross was going short the Treasury Market. We stated in one of several pieces on the subject our hypothesis for the summer:
"If we look back at last year for guidance, we remember that the Greek and European crisis was known for months, the selloff only occurred when conditions were optimal. As in, the Fed removing stimulus from asset prices, limited upside gains versus substantial downside correction losses.
Then all of the sudden we had a crisis on our hands, only differentiated by the fact that Sellers stepped into the market, and all the sudden, bad news was everywhere. It is only bad news in market terms if buyers decide to sell, and just like in 2010, the above reasons serve as likely catalysts for similar selling this year around this time. Think along the lines of a 20-25% correction in most asset classes over the next 4 to 5 months. Just think how much better your portfolio would look if you locked in your profits last April, parked your money in a money market fund, waited for the Summer selloff, and then got back in the market during the historically stronger investment months for the last quarter of the year, (October-December) where money managers push up asset prices into the year end to make their numbers."
Well, what PIMCO and Bill Gross should have noticed is that around April 6th of 2010 the very same time Treasuries went on a similar run with a 3.97% yield on that date running to a 2.38% yield on October 8th in an eerily similar 159 basis point move in the subsequent six month time period (See Chart above). What were they thinking?
End of QE2 = Start of Risk-Off Trades
The obvious signs are that if you have a 25% correction in asset classes as highs are reached in early April, and QE2 comes to an end, removing artificially inflated stimulus it was obvious that we were going to experience the same sort of “flight to safety” trade as 2010 where bad news was really bad news because there was a huge artificial support that was being taken away from the market, and that when this flight to safety occurred, that bonds were going to be the main beneficiary.
You do not get a 25% correction in risk asset classes like Oil and Equities and not have a stampede run into the “Safety Trade”. There are two main fundamental trades in play these days, the “Risk On Trade” where you go out of Bonds and into Risk Assets like Commodities and Equities. After all, this was Bernanke`s stated goal to incentivize investors to take on more risk by getting out of deflationary safe assets like bonds and into the riskier classes.
Well, when QE2 ended it was logical that the trade was going to morph into the other trade, the “Flight to Safety Trade” where investors go out of riskier assets like Commodities and Equities and seek return of capital in Bonds and Treasuries.
Bond King's Cardinal Sin
PIMCO made the cardinal sin of buying at the proverbial top of the Treasury market in terms of yield, or put another way, selling at the bottom of the Treasury market in terms of price. And yes at times this can be a respectable technically based trading strategy, but not in the context of other macro events taking place regarding debt concerns in the US and Europe.
Flawed Inflationary Bias
I think part of the flaw in PIMCO`s analysis is that they looked around at commodities like Oil and this confirmed their inflationary bias, i.e., a 70`s style inflation era of high commodity prices and bond vigilantes demanding higher yield for financing any debt.
But the flaw is that we were in a true inflationary period in the 1970`s due to high commodity prices and high interest rates, but the main difference between the two eras is that we are in a major deflationary era because of high debt issues on governmental balance sheets.
Moreover, higher oil prices actually are deflationary this time around because they are not due to fundamental supply shortages like the 1970`s but rather artificial monetary policies. So when you couple weak demand and high artificially inflated Oil prices you get a deflationary stunt of economic growth and increase the chances of sending the economy into a prolonged recession because the real economy cannot support higher Commodity prices.
And in any deflationary period the “Safety Trade” is going to prevail over the “Risk On Trade”. I think this is one of the main errors in PIMCO`s analysis, they took the wrong reading from artificially high Oil prices, they thought that these prices were here to stay when the demand levels were at a negative year-over-year 3% reading moving to the 5% negative level.
Flawed Assumptions in Model
The other main contributing flaw in PIMCO`s analysis is probably that they viewed the financial world as it was at the beginning of April, and not how it was going to be in May. PIMCO looked around and surveyed their surroundings, and then just extrapolated the status quo at the time forward utilizing some forward looking modeling assumptions, but they never really questioned whether there was something amiss with their status quo in the first place.
The real fault was not recognizing that the status quo was only a temporary phenomenon and about to change in a radical way after the options expiration in April; and the template for knowing this was staring them in the face the entire time because the almost exact carbon copy happened the year before.
"Group Think" Scenario?
There are a lot of smart minds at PIMCO, and I am sure they realized they were wrong at some point on this trade and cut their losses. But oh what could have been? I guess a couple of possible takeaways from this failed strategic analysis and subsequent trade on behalf of PIMCO is to have enough divergent views within an organization so that enough challenging of ideas and assumptions takes place in order to ferret out potential shortcomings in one`s original hypothesis before capital is ever allocated to the trade. It seems that PIMCO suffered from a major dose of “Group Think”.
Questionable Decision-making Process
The more troubling part would be that analysts within PIMCO were not listened to at the analyst level, and the strategic decisions were made solely at the Executive level. The third alternative is that the analysts were afraid to speak up once a base hypothesis was formed within PIMCO, and they didn`t feel comfortable “Rocking the Boat” so to speak.
History Sometimes Repeats Itself
The other lesson to be gleaned by this failed trade is that even the experts, the specialists within their field make mistakes, so the Bond Experts messed up what was probably one of the easiest bond trades of the last five years.
It was the perfect setup, and all PIMCO had to do was read the correct tea leaves, and make a fortune for their clients. A simple look back to last year was the writing on the wall that PIMCO missed in their faulty Treasury short.
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PIMCO needs to hire better analysts at the analyst level, they have enough CNBC Suits that cannot analyze their way out of a paper bag!
Bonds ran 18% up, and Stocks ran 18% down, so depending which train you're waiting to catch its an Irene style WASH. 28/30 Dow stocks yield more after-tax than 10 year Treasury. And we're looking for (another) Wave 5?
better to be early, than one day late
What pimco did not anticipate was the panic by some investors to get into assets that yielded below zero.The bull market in bonds is over 30 years old.Yields are near all time lows.Government finances are in shambles.Do you want to hold assets that yield below zero.If deflation does take place that makes it harder for ALL debtors to pay off their obligations.And who is the largest debtor in by far.Of course the Feds.There is only three ways to pay off debts.One is to tax.two is to inflate and three is to default..The bet that bond buyers are currently making is that we will have deflation.But deflation will make it impossibel for the US to pay back its debts ,thuis resulting in default Within in a few years when the mania to buy assets that yield below zero fade,investors are going to ask ,what the heck was i thinking when i tied up my money for no real return.I bought bonds when they yieled %8.5 in the panic of 1987 and got killed for a short period of time.I sold bonds when they yielded %2.5 and have gotten killed.it looks to me like just as good of a bet.
You have the right idea, but stop short of DEFAULT. If the rate of interst is 0.000001% ask yourself, will they not pay that? And what if they said you can't cash out, you must roll over? PIK? This country will not default, nor will investors get their principal back- call it what you will, but if your credit card was charging you 0.0001% Diddly-Shit would YOU ever pay them back? No, send them a penny and buy INTC who pays 4.25% taxed at 15.
http://www.xtranormal.com/watch/12373724/q-a-w-larry Not so far-fetched, matter of fact Benbernake has asked for an extra day in September to explain this to his colleagues who lack his imagination (and mine).
It's hard to out-guess a manipulated market.
In iPad World, not far from Fisher-Price Land, people learn second-party information through third-party aggregators.
In the first-party information land of show-ups, no one here was there or knows because they were there or pretends to have been there.
WTF knows Jack?!
.....and Kilroy wasn't much of a traveler either.
i think you will find that PIMCO held foreign bonds instead of Treasuries if you check out the published data.
I think they are ripe to be shorted. The time frame now is the hardest part to predict. I just don't see how rates can go lower from here, but I'm not ready to go all in. Fighting the fed has been a loser game and yet at some point soon this is going to unravel.
Remember th Golden Rule...He that makes the rules wins the gold. Who the hell wants to participate in this Soviet Style Market?
Or maybe Pimco was busy buying all those TLT shorts they instigated and selling all those TBT shares they already had on hand... While their clients paid margin they sat back and smoked GurkhaHMRs while they watched their proprietary desk rake it in. Who said anybody has to tell the truth anymore?
Bill Gross has CASH, all others own PAPER that will be rolled over at continuously lower yields. Those "profits" you speak of won't be realized because people won't sell, and to think an investor the size of Pimco would be able to sell later on is impossible. By selling into the rally, Gross/PIMCO has taken boatloads of cash in exchange for their bonds- a brilliant move in and of itself, and way ahead of the crowd.
PIMCO was not wrong, just early. It's an irrational market, both bonds and stocks are up, one of them is wrong. Gold price says bond market, but it is hard to bet against US Gov't and the Fed with all the ways they can manipulate markets. I bought some Jan 12 put options on TLT at $96 strike price to have some exposure to bond prices falling. We will see what happens, I may be early as well.
A broken clock is early twice a day, too.
What the author is missing...
PIMCO did and said precisely as PIMCO was 'encouraged' to do and say.
Gee he missed piling in 2% bonds with 6% inflation. Im sure Bill Is crying his eyes out with foriegn bonds with some return.
I am pretty sick and tired of that Gross and his pal El-Erian marching out like experts on major news networks. Serves the morons right! Pretty pathetic they missed this trade so bad, so very, very bad. I personally still think we are going to see the 10year in the low 1%s before yields head up (like 1.1%) ...
If the ten year goes to 1.1%, I will go into refinance mode yet again. I just did a 15 yr fixed at 3.375%. Pretty soon they will pay us to borrow money.
Hardly surprising that PIMCO got it wrong. The biggest herds tend to be the last to capitulate, usually right at the biggest turns. In fact, it might be argued that thei capitulations Create those turns.
TBAF
Too Big And Fail
STFU and Trade, Trader
"The obvious signs are that if you have a 25% correction in asset classes as highs are reached in early April, and QE2 comes to an end,"
So you sold or shorted gold in April ?
Or just after QE ended in June ?
Gold is up higher then treasuries since the "risk off" ending of QE.
Bond vigilantism is taking the form of gold buying this time. Watch out treasury lover
Bill Gross, John Paulson and all the rest of them are absolutely brilliant money managers when the trade is rigged. Without inside information and influence, they're just a bunch of clowns. Sooner or later, they all start drinking their own bathwater.