Pimco’s Bill Gross Says Bonds Have Seen Best Days (Update2)

By Thomas R. Keene and Susanne Walker

March 25 (Bloomberg) -- Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said the almost three-decade bond market rally may be drawing to a close.

Excess borrowing in nations including the U.S., U.K. and Japan will eventually lead to inflation as governments sell record amounts of debt to finance surging deficits, Gross said. Pimco, which announced in December that it would offer stock funds for the first time, is advising that investors buy the debt of countries such as Germany and Canada that have low deficits and higher-yielding corporate securities.

“Bonds have seen their best days,” Gross said in a Bloomberg Radio interview today from Pimco’s headquarters in Newport Beach, California. “We are focused more in spread space than in yield space. Durations should be shorter than index and you should be taking a little more risk in terms of spreads.”

Yields on two-year U.S. Treasury notes are likely to rise to 1.25 percent to 1.5 percent from 1.08 percent in the next year as the economy strengthens and the Federal Reserve begins to increase interest rates, Gross said.

“Real interest rates are moving higher,” said Gross, who co-founded Pimco, which manages about $1 trillion in assets. “That’s the main bear element in the bond market.”

Real yields, which take into account inflation or deflation, have increased to 1.71 percent on 10-year Treasuries from 1.12 percent at the end of last year.

‘New Normal’

The yield on the 10-year Treasury note reached a high of 15.8 percent in September 1981 and a record low of 2.03 percent in December 2008 during the height of the credit crunch. The notes yield 3.89 percent today.

Investors should avoid the debt of the U.K. and invest in shorter-maturity U.S. and Brazilian securities and longer- maturity German and “core” Europe bonds, Gross, 65, recommended in a commentary yesterday. Under what Pimco calls the “new normal,” Investors should expect lower-than-average historical returns with heightened government regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy.

“Sovereign decoupling is symptomatic of the realization by the market that sovereign credits are vulnerable at some point down the road,” said Gross, who serves as co-chief investment officer with Mohamed El-Erian.

Gross increased holdings of bonds from non-U.S. developed nations in his Total Return Fund for a fourth month in February, taking them to the highest level since May 2004, according to data on the company’s Web site on March 17.

Total Return Fund

The fund manager raised the proportion of the securities to 19 percent of assets in February from 18 percent in January. Gross increased U.S. government-related debt to 35 percent from 31 percent, the first rise since October 2009, and lowered net cash to 2 percent from 9 percent.

The $214 billion Total Return Fund returned 16 percent in the past year, beating 54 percent of its peers, according to data compiled by Bloomberg. As of December, Pimco managed $1 trillion in assets. Pimco is a unit of Munich-based insurer Allianz SE.

The U.S. budget deficit reached a record $1.4 trillion for the fiscal year that ended Sept. 30 amid falling tax revenue from the recession, a bailout of the banking and auto industries, and the $787 billion economic stimulus package.

U.S. Treasuries have returned 0.9 percent this year, compared with 2.7 percent for German government bonds and 0.5 percent for U.K. gilts, according to indexes compiled by Bank of America Merrill Lynch.

Equity Funds

All Group of Seven countries, except Canada and Germany, will have debt-to-GDP ratios close to or exceeding 100 percent by 2014, John Lipsky, first deputy managing director of the International Monetary Fund, said in a speech March 21 at the China Development Forum in Beijing.

Pimco filed with U.S. regulators in December to start a stock mutual fund that can also invest in bank loans, junk bonds and distressed securities. The Pimco Global Opportunities Fund will buy securities and financial instruments “economically tied” to at least three countries, one of which may be the U.S., according to a company filing.

Investors should “move outside of the United States,” in choosing stocks, Gross said. Emerging and developing countries because they are now “creditor countries” that feature strong growth while developed countries are the “debtor countries” and carry weaker growth, he said.

The “typical suspects” to invest in include Brazil, China and India, Gross said.

----With assistance from Michael McKee in New York. Editors: Dave Liedtka, Gregory Storey

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net