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A year ago Bill Gross went on TV to say he will be under-invested Treasuries because they offer no upside. Now that U.S. Treasuries are up 9% (based on iBoxx Treasuries Total Return Index) and the 10-year note is up nearly 17%, Gross had a paradigm shift.

PIMCO's letter (attached) states that the process of deleveraging in the U.S. has only just begun. That is indeed true (as can be seen in PIMCO's chart below), but it's hardly a new development and was just as much true a year ago.

Source: PIMCO
"Durations and average maturities should be at their maximum possible limits" states the letter. So now Treasuries have value? With the 10-year note yielding under 2%, and the 5-year below 90bp? Of course the answer PIMCO offers is that longer durations should be in TIPS to protect against inflation. But TIPS yield is now negative (chart below), so with a 2% inflation rate, one is roughly at the same yield as with the 10-year note. And with all the deleveraging that PIMCO expects (as one looks at the debt chart above), deflation should be much more of a concern than inflation - in which case Gross should be in Treasury notes, not TIPS. Either way there is a consistency issue.


(Click to enlarge)
10yr TIPS yield (Bloomberg)

The apocalyptic tone of the letter, as Gross switches from "New Normal" to "Paranormal", makes one wonder if this is a way of apologizing to investors for underperforming in 2011 (or scaring them into coming back.)

WSJ: Mr. Gross's fund was a laggard last year. The fund handed investors a return of 4.2%, compared with 7.8% on the Barclays Capital U.S. Aggregate Bond Index, according to Morningstar.

As much as PIMCO makes some great points in the letter, it's difficult to reconcile the current investment thesis with last year's anti-Treasuries rhetoric.

Enjoy.

Pimco Jan 2012 Letter

Source: Bill Gross's Reversal On Treasuries