Gross Says Corporate Bonds Irrationally Priced as Risks Rise – Bloomberg 02-27-13

Salient to Investors:

Bill Gross at Pimco said:

  • Asset-price irrationality has risen to 6 on a scale of 1 to 10.
  • Corporate credit and high yield bonds are somewhat exuberantly and irrationally priced, spreads are tight, profit margins are at record peaks with room to fall, and the economy is still fragile.
  • Junk bonds will realize 3 percent to 4 percent returns when today’s 5 percent to 6 percent yields are adjusted for future defaults and recovery values.
  • The Total Return Fund reduced its holdings of investment-grade credits to 9 percent in January from 10 percent in December, Treasuries are the largest holdings at 30 percent.
  • Growing central-bank tolerance of inflation means investors should hedge higher prices by buying TIPS, and avoid buying longer-term Treasuries and advocated notes with 5 years to maturity.
  • High-yield and equity returns have been unduly influenced by quantitative easing and the exuberant migration of institutions and households to risk assets dependent on favorable economic outcomes, so if and when Fed support dissipates or if the economy remains anemic, investors should be cautious and temper their enthusiasm.

Banks have underwritten $89.6 billion of high-yield debt in 2013, up 36 percent from the same period in 2012. Morningstar poured $33 billion into junk bond mutual funds and ETFs in 2012, up 55 percent from 2011.

The Bank of America Merrill Lynch Global High-Yield Index shows the yield spread between junk bonds and government debt has contracted by 16.69 percent since 2008 to 5.24 percent.

FRB Governor Jeremy Stein says some credit markets are showing signs of excessive risk-taking.

Kansas City FRB President Esther George has warned of risks from farm land prices at historically high levels.

Read the full article at http://www.bloomberg.com/news/2013-02-27/gross-says-corporate-bonds-irrationally-priced-as-risks-rise.html

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