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The King Of Bonds Is Shorting Bonds

Apr. 22, 2015 12:15 PM ETJNJ, BUNL5 Comments
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I found this interview of Bill Gross on CNBC very interesting: finance.yahoo.com/news/bill-grosss-short...

Now of course Mr. Gross is talking his book and trying to garner a little publicity for the Janus Unconstrained Bond Fund (JUCTX) which he recently took over. However, if one looks at the actual holdings of JUCTX (as of 3/31/ 2015) it is rather telling of what the "King of Bonds" thinks about the current bond market:

Not only is Mr. Gross short the German Bund, but if you look deeper, you will see he is also short long term US Treasuries and his effective duration for the whole portfolio is under 2 years. Additionally, the short RXM5 position (short 5 year German Bunds) is his largest single position and overall his net non-domestic developed market bond position is -8.7%. So the short position is not small; he has high conviction. Now understand Mr. Gross has to invest in bonds, the mandate of the fund doesn't allow him to switch to equities. However, it is obvious he does not think German Bunds or generic AA and above rated domestic bonds for that matter are the place to be (over 75% of holdings are BBB or below). As evidenced in his holdings, Mr. Gross is clearly afraid one day rates will rise and cause significant losses for high quality bonds with any duration to them.

As an example of what could happen I chose one of the largest Johnson & Johnson (JNJ) AAA bonds. According to Morningstar (quicktake.morningstar.com/StockNet/Bonds...) it currently trades at 138 with a 5.95% coupon and a yield to maturity of 3.5% ($3.50 per year in earnings on a $100 investment). Where rates to rise 1% this bond should lose about 13.8% in value (13.8 years duration). In other words, were you to buy this bond today and interest rates rose 1%, it would take about 4 years for the yield to make up for your expected loss in price. If you ask me, this is an example of picking quarters up off the railroad track when there is potentially a freight train barreling down upon you. Now I don't particularly see any freight train in sight, but like Mr. Gross, I also don't have a lot of faith in my ability to time interest rate changes. Many holders of JNJ bonds will say I bought at issuance and plan to hold to maturity (2037), so I'm making 5.95%. That is fine, but realize you could also sell now for a 38% capital gain and reposition the money elsewhere or just hold it in cash. That 38% in immediately realizable capital gain represents over 6 years worth of yield. You could sit in cash for 6 years, using the capital gain to substitute for your income, and see if there are better opportunities then.

In the interview Mr. Gross discusses timing saying he doesn't know when, but that it is costing him little to short the bund, 0.1% yield (no that's not a typo, only 10 basis points). He further elaborates that he see's -.2% yield as the potential downside (the ECB has indicated they would not buy German Bunds below -.2%) whereas the potential (eventual?) upside to his short position is significant.

Those of you holding 3 year+ duration AAA corporate bonds should take note, the "King of Bonds" doesn't particularly like your position.

Analyst's Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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