Tuesday, August 02, 2011

One week ago...

...I sent the following to market participants:

Time is the major variable here, but since this is a 401(k) I am assuming that we are investing over a multi-year period, and that we are discussing U.S. assets only. (we have discussed before regarding the U.S.'s unique position as "only port in the storm" given global imbalances)

I expect government bonds to increase in value (with corresponding yields decreasing) no matter the outcome of the Debt Ceiling discussions as Bernanke realizes that another round of Quantitative Easing is inevitable. Thus, the supply of government bonds will be lowered (through Fed purchases) and the cash that is injected into the system will need a home. Up until now, that "home" has been stocks. Bernanke knows that combating deflation is easier than fighting inflation, so he is willing to continue these programs in order to keep yields low. I completely disagree with his strategy, but that is neither here nor there.

Thus, moving assets from equities to fixed income is not advisable.

As an aside, "fixed income" is not inherently less risky. If Bernanke defeats deflation (and currently, only commodity prices and energy are seeing inflationary pressure - there is NO pressure on wages) he sews the seeds for inflation down the road (3+ years away). The Fed will have to aggressively raise rates to combat this threat. Holding Bonds in a period of high and rising interest rates is VERY painful.

And today, The King of Newport Beach agrees:

By Murray Coleman

The Federal Reserve is likely to start laying the groundwork for a new round of quantitative easing later this month, Pimco’s Bill Gross said on CNBC today.

The manager of the world’s biggest bond fund, the Pimco Total Return (PTTRX), is also predicting that a third Fed stimulus program will take a different path than past rounds.

Such a QE3 plan will probably involve a range of other assets besides Treasuries, Gross noted. He said the Fed could publicly vow to keep rates at a maximum 0.25% as long as inflation remains at 2.5% or less, for example, to provide more room for Treasuries to rally.

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