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Thursday, June 30, 2011

Leon Cooperman on CNBC

Leon Cooperman of Omega Advisors was on CNBC today discussing the effects of QE2 ending, and his current thoughts on the market (which he is fairly bullish). Nothing really earth shattering but I think he does a nice job framing his argument on why he continues to be optimistic.


Carson Block on Bloomberg

Carson Block was recently on Bloomberg discussing his business, his Sino Forrest short and other items.

Overall its fairly enjoyable.

Tuesday, June 28, 2011

Muddy Waters announces a new short position - Spreadtrum Communications

The infamous Muddy Waters and Carson Block are out with another short. This time they are shorting Spreadtrum Communications (NASDAQ: SPRD). They point out what they believe are a couple of accounting irregularities.


Highbridge Makes Loan to LA Dodgers

Reports are coming out stating that Highbridge Capital is loaning the LA Dodgers $150m at 10%. Interesting that we see them move in this direction, especially after David Einhorn bought his stake in the Mets. Seems this form of distressed purchases in major league baseball teams is becoming more common place. For more details please see the story below:

While Major League Baseball appears happy to let hedge fund manager David Einhorn's millions float the financially troubled New York Mets, the intervention of another hedge fund in the sport's other big money mess appears a good deal less welcome.

The Los Angeles Dodgers yesterday filed for bankruptcy protection in Delaware, announcing they were poised to miss $38.7 million in financial commitments later this week, including $20 million in payroll. The team's owner, Frank McCourt, says he needs a $150 million loan from Highbridge Capital Management to meet those obligations.

Should the deal be approved by the court, Highbridge would extend a $150 million one-year loan to the Dodgers on very favorable terms for itself. The hedge fund, a division of JPMorgan Chase, would be guaranteed at least 10% interest, as well as a $4.5 million deferred commitment fee, 0.5% of the unused part of the loan paid monthly and first dibs on the Dodgers' assets.

The Dodgers, who would draw $60 million of the loan immediately, would get more time to force baseball Commissioner Bud Selig to accept its proposed television rights deal, the proceeds of which McCourt needs to satisfy a $385 million divorce settlement between himself and his ex-wife, Jamie, the Dodgers' former CEO. The team said that Highland was the only lender it approached willing to offer at least $40 million right away.
Selig has rejected the $3 billion TV deal, and in April seized control of the team. He also made clear that McCourt's bankruptcy filing had done nothing to endear him more to the commissioner.

"The Commissioner's Office has spent the better part of one year working with Mr. McCourt and his representatives on the financial situation of the Los Angeles Dodgers, which was caused by Mr. McCourt's excessive debt and his diversion of club assets for his own personal needs," Selig said in a statement. "We have consistently communicated to Mr. McCourt that any potential solution to his problems that contemplates mortgaging the future of the Dodgers franchise to the long-term detriment of the club, its loyal fans and the game of baseball would not be acceptable."

"To date, the ideas and proposals that I have been asked to consider have not been consistent with the best interests of baseball," Selig continued. "The action taken today by Mr. McCourt does nothing but inflict further harm to this historic franchise."

Additional details can be found via a Bloomberg article here.

Friday, June 24, 2011

Paulson supposedly only had $107m loss in Sino Forrest

AR is out with an excerpt from a recent Paulson letter claiming that they only had a $107m loss in Sino Forrest.

According to the letter, Paulson’s initial interest in the firm followed a January 2007 news report that CVC Asia Pacific and Macquarie Bank were considering a bid for Sino-Forest. Paulson began researching the company and started building a position after news that Sino-Forest’s potential acquirers would not be bidding sent its stock price down. Then, in March 2007, after Sino-Forest sold a 16% stake of its stock to an investment group led by Temasek, Singapore’s sovereign wealth fund, Paulson & Co. decided the Chinese company’s stock was undervalued and suggested to the company that it move its stock listing from Toronto to Hong Kong or Shanghai to improve its valuation.

“As a passive investor in public companies, Paulson has access to the same information that everyone else in the securities market does. Like other public market investors, we must rely on audits and underwriter due diligence for comfort that financial statement and disclosures are accurate and reflect the true state of affairs at companies with publicly traded securities,” said Paulson’s letter, noting that the firm conducted extensive due diligence on its investment. Additionally, the firm cited several legal and institutional controls that Sino-Forest had passed. Among them: financial and legal auditing by the Toronto Stock Exchange beginning in 1995; financial statements approved by such auditors as Ernst & Young; eight separate securities offerings between 2004 and 2010 and a large following by sell-side research analysts and ratings agencies. Though Paulson stopped short of denouncing Sino-Forest’s accounting, the firm attributed its decision to unload its [full] position in Sino-Forest to what it believes is irreparable damage to the company’s stock from a June 2 report from Muddy Waters Research that questioned the company’s public disclosures and financial statements.

Thursday, June 23, 2011

Marc Faber on Bloomberg

Marc Faber was on Bloomberg today discussing the likelihood of an upcoming pullback (he thinks the market has hit its highs for the year), commodity pricing, and the potential for a bubble in Asia (he also discusses the recent Chinese frauds in the U.S.).


Notes from Ackman, Marks, Greenblatt, Cooperman and More...

Marketfolly did a nice job posting up notes from the recent CIO/CEO Leaders in Investing Summit that took place on Tuesday at The Metropolitan Club of New York. Not surprisingly ther was some consensus that bonds are overpriced compared to stocks and that in the finanical arena stocks are the current place to be. Many also shared their concern over the faltering economy and the chance of continued pull back.

Ackman talked briefly about JCP and FDO. For reference Pershing's FDO presentation was posted here.

Overall it was an ok event - nothing too revealing.

For more detail please read Marketfolly's summary here.

Monday, June 20, 2011

Paulson sells out of Sino Forrest

Pauslon & Co just released documentation stating they have sold out of Sino Forrest. This does not bode well for the stock as it basically confirms that even the "smart" money has been duped out of an estimated $750 million. I would expect it to trade down further tomorrow. This just goes to show you why you should never invest just based on the fact that other supposed smart investors are investing. Always do your work and hopefully we can all avoid scenarios like these.

Paulson Document

Friday, June 17, 2011

Byron Wien - Blackstone Group - Time for a Pause

Byron Wien - the chief market strategist at the Blackstone Group is out with his latest, "Time for a Pause". In it he discusses our current positioning and where he thinks the market is headed and how the recent bout of pessimism is likely ultimately good for the market.


Byron Wein - Blackstone - Time for a Pause

Good Article on Howard Marks

Bloomberg came out today with a very good indepth article on Howard Marks and how Oaktree has grown over time.

The link to the article is below:

Tuesday, June 14, 2011

Muddy Waters - notes from Sino Forrest Conference Call

Sino Forrest just held their conference call and Muddy Waters has produced a set of notes commenting on the call. The notes can be found below:

Reaction to TRE Q1 Earnings Call
The selloff in TRE shares following this morning’s call illustrates our overall feelings about management’s responses to questions. The highlights are:
• Ernst & Young has been unable to complete its review of TRE’s Q1 numbers.
• Chairman / CEO Allen Chan personally guarantees that TRE has disclosed all related party transactions. However at no time did management address TRE’s relationship with Lei Guangyu, the only disclosed AI. Mr. Chan stated that Mr. Lei is a major AI.
• TRE’s suppliers (agents) and buyers (AIs) are two different parties. As shown by our analysis of five suppliers, none of which were capable of selling nearly the volume of timber TRE claims, TRE had made this point clearly before.
• TRE added an odd twist to its disclosed business model. AIs now apparently do not pay TRE directly (see our discussion of the various problems in doing so). Rather they pay TRE indirectly by paying TRE’s “designated purchasing agents”, which then purchase more parcels. As we wrote in our initial report, a consistent theme of TRE’s stated business practices is that they are unnecessary, overly complicated, and risky for a legitimate business. Is the designated purchasing agent an AI-squared? We look forward to more detail on this new facet so that we can analyze the legal and practical issues.
• Mr. Chan explained that the AI model came into being because TRE could not form WFOEs in the 1990s to conduct this business. As we pointed out in our report, after TRE’s EJV with the Leizhou Forestry Bureau terminated (due to TRE’s failure to contribute its capital), TRE had a WFOE that had a business scope that permitted it to do business directly. Aside from that point, management did not explain why it continues to use an AI model today. Thus the AI model makes no more sense now than it did before this explanation.
• TRE still refuses to disclose its AIs’ identities for “competitive reasons.” It cited an example from the 1990s when an AI’s identity was disclosed, and then smaller competitors undercut TRE’s prices and won business. This explanation strikes us once again as TRE relying on everybody in the chain (e.g., the farmers) being ignorant. We do not dispute that TRE’s AIs are overpaying TRE (allowing TRE a 55% gross margin on standing timber). However, TRE’s AIs would be among the largest buyers of timber in China – we do not understand how revealing their identities could subject them to any greater information about the extent of this overpayment than they are currently in a position to receive.
• It will apparently take PWC two to three months to complete its investigation. In our experience with much smaller frauds / companies, this is an aggressive timeline.
• CFO David Horsley stated that TRE can not confirm whether the AIs actually make TRE’s tax payments. He said they “just don’t know” whether the payments are made. Again, the AI model is unnecessary, overly complicated, and risky for a legitimate business.
• Allen Chan did not answer a question about how much replanting TRE did in the quarter, other than to say that TRE is progressing with the program. He later responded to a question about whether TRE is in compliance with PRC replanting regulations by stating that TRE would have heard from the authorities if it were not. We believe that investors underappreciate the replanting metric (or lack thereof). China has in the past experienced devastating floods due to harvesting without sufficient replanting. If TRE were not fulfilling its obligations to replant, this would complicate the ability of either TRE or its AIs to obtain harvesting permits for the standing timber.
• Management stated something to the effect that it could remit its cash out of China by closing or selling the BVI entities, and then remitting the cash. This was not a confident or clear explanation, and it raises more questions than it answers. Along those lines, when TRE was asked to clarify this statement during the Q&A, nobody answered and the questioner was mysteriously dropped. TRE had some notable blocks / drops of other awkward questions. TRE cut off the Nomura analyst Anissa Lee rather than answering her question asking for more details on where the cash balances are kept. Management also failed to attempt to answer a question about whether its banks are uncomfortable with extending credit. Instead of answering, there was a death ray type of sound toward the end of the question, and the questioner was no longer there. In true memory hole fashion, management moved onto the next questioner without making any statement in response to the question.
• William Ardell stated that PWC is going to check balances in every PRC bank account at the branch level. As LFT, CCME, and other frauds show us, such confirmation should also take place at the central level of the banks – branches are easily corrupted.
• Regarding the dearth of information in the data room, Allen Chan said that he would have to check with “our people” about putting more information online. We advise investors to take note of this delay.

Pershing Square - All in the Family - Presentation from Ira Sohn Conference

Below please find the slides from Pershing Square's presentation at the Ira Sohn Conference. Yesterday the speech transcript was posted (can be found here).

Without delay, enjoy:

Pershing Square - All in the Family - 2011.05.25

Friday, June 10, 2011

Capital Structure Arbitrage Trade Idea

Came across an interesting capital structure arbitrage trade idea and thought I would share it with the group. If anyone has any feedback, feel free to leave a comment:

The opportunity consists of two capital/arbitrage trades within the Claire’s capital structure:
1. Long Sr Notes due 2015 – Short Sr Subordinated Notes due 2017; and
2. Long Sr Notes due 2015 – Short Second Lien Notes due 2019.

There are a number of headwinds facing retailers entering the second half of 2011. These include:
1. Higher commodity (input) costs;
2. Higher labor costs in China; and
3. Depressed discretionary consumer spending due to higher gas and other

Weaker retail credits should show greater volatility than stronger credits. Furthermore, logically one would expect the mid-to lower end to be more volatile than the luxury area. Claire’s is highly leveraged retailer of fashion accessories and jewelry to tweeners and teenagers. Claire's debt stack can be seen below:

In 2007 Claire's was LBO'd by Apollo for $3.1 billion. Most of the Claire’s products are discretionary in nature. Claire's merchandise inventory to debt ratio is among the lowest in the high yield retail universe. Sales and operating performance would likely underperform in a more difficult economy. Moreover, most of Claire's merchandise comes from Asia – primarily from China. Given that it is one of the most highly leveraged retailers, one would expect the note prices to come under pressure in the event of a downturn in either the high yield market or in operating performance.

Long Sr Notes due 2015 – Short Sr Subordinated Notes due 2017 The Sr Notes are the first notes in the capital structure that mature. The company has been using some of its free cash flow to purchase its Sr Notes in the open market. In the past, the company has also purchased some of its Sr Subordinated Notes in the open market as well. However, the company has nearly exhausted its ability to do so, as only $6.0 million of availability remains under its restrictive payment basket.

For nearly an even dollar, an investor can go long Claire’s Sr Notes and short its Sr Subordinated Notes. The Sr Notes are 1 turn less leveraged, and mature two years before the Sr Subordinated Notes. Some Wall Street analysts believe that the Sr Notes will be supported by continued open market purchases by management. In addition, the notes could be refinanced with proceeds from a new bank loan facility, second lien notes or other sr notes. So suffice it to say the senior notes have some interesting aspects to them that the junior lack.

Long Sr Notes due 2015 – Short Second Lien Notes due 2019. The YTW for this trade is about the same, given the shorter duration of the Sr Notes, the STW is 120 bps greater.

Moreover, Claire’s may increase its bank loan or issue an add-on to its 2nd Liens in order to refinance its Sr Notes. Given the limited hard assets associated with Claire’s and the substantial amount of debt ahead of the 2nd Lien Notes, the security attached to the 2nd Lien Notes probably won't be that valuable in a distressed situation.

The chart below shows the liquidation stack:

I think this trade has potential merit. I am a believer in the thesis of potential threats from a slowing economy and it is clear that the junior more levered pieces is definitely more subject to volatility. I think this does a good job of getting the lure in the water - if interested the next step is to truly understand the cash flow nature of the business in order to ensure that your senior is truly worth something in a potential distressed scenario (which given the leverage ratios present may not be all that unlikely).

Bruce Berkowitz of Fairholme on Bloomberg

Bruce Berkowitz of Fairholme Capital Management recently spoke at the Morningstar Investment Conference and Bloomberg was there to snag an interview. In the video below Berkowitz discusses his views and holdings in financial stocks such as BofA, Goldman, etc. While Berkowitz's performance has been less than stellar year to date - but over time he has proven his worth - I am starting to think he might be right on these in the long run. Gratned my trader gut says we are apt for continued weakness in the market until the fall.

It is also worth noting that Michael Price shares this bullish view on Goldman and financials in general.


Thursday, June 9, 2011

Michael Kao - Akanthos Capital Management presentation from Value Investing Congress West

Below please find Michael Kao's presentation from the Value Investing Congress West. In it he presents his thesis for Fannie Mae and Freddie Mac preferreds. It is a good presentation and definetely deserves a look.


Akanthos Capital Management - A Treasure Chest Beneath a House of Cards - 2011.05.4

Jim Rogers on CNBC

Recently saw an interesting video. A little bit of a replay from what we have already heard but still worth passing along. Jim Rogers who went on CNBC to discuss his views of the U.S. and Global economy. He talks about commodities and his bullish stance on China (no shocker here). But what is interesting is he talks about his trading stance on the USD despite his bearish positioning. This is similar to what John Taylor said previously. He also talks about how he is short technology stocks and thinks they are in or near bubble phase.

Monday, June 6, 2011

John Taylor of FX Concepts on Bloomberg

After his CNBC appearance last week John Taylor went on Bloomberg today again to warn of his bearish views on equities and the commodity space. He also thinks the USD is going to go up. He also talks about how weak the Euro is.

Overall its pretty interesting.


CNBC's take on the Muddy Waters vs. Paulson & Co Sino-Forest debate

Not wanting to feel left out CNBC also gave some coverage to the Muddy Wattes vs. Sino-Forest / Paulson & Co debate. Nothing too insightful but does a good job of framing the debate.

Muddy Waters vs. Paulson & Co - Rd 2

Carson Block of Muddy Waters recently came out with a scathing short report on Sino-Forest (OTC: SNOFF or TRE.TO). This is not your typicaly chinese blank check company as Sino-Forest's largest holder is none other than Paulson & Co. Since release the release of the report (posted for your viewing convenience below) the stock has cratered (down 70% since its release) and Paulson has lost over a half a billion in the trading since the release of the report. Carson Block went on Bloomberg TV today to discuss his short and the company's retort. He says he is still short and thinks its worth zero.

It is interesting to see how this story plays out as Paulson is no sucker and the stock has really tanked since the report came out (although it is up a bit today). Keep an eye on it as someone could make a lot of money either on the short or long end of this story.


SAC Capital Monthly Historical Performance

ZeroHedge recently posted what they claim to be is SAC Capital's monthly performance since inception. It is fairly interesting to look at. Needless to say Steve Cohen and friends have done a terrific job. Amazingly they have only had three down months in the past 29 months - granted the market has been fairly upward oriented in that time frame it is nonetheless impressive.

Any way you slice it one down year in the past nearly two decades in crazy impressive - I can see why people allow SAC to charge the insane fees that they do.

Thursday, June 2, 2011

John Taylor of FX Concepts on CNBC

John Taylor the manager of FX Concepts - and arguably the best currency trader in the world was on CNBC this morning discussing the potential of a recession in 2012. He feels fairly confident that we will have at least two quarters of negative GDP growth and will likely have a weak stock market as well. He also discusses the potential for a QE3. He is bullish on the U.S. dollar as it is still the reserve currency and Europe is in shambles, this is slightly counterintuitive given his bearish stance on the U.S. economy but does make sense from an practical standpoint.


Wednesday, June 1, 2011

Transcription of the Winning presentation from the Ira Sohn Conference

Below please find a transcription of the winning presentation from Sunjay Gorawara on BridgePoint Education. Enjoy.

2011 Ira Sohn Conference – Bridgepoint Transcript

Latest missive from PIMCO - Bill Gross

Bill Gross is out with his latest outlook commentary. I don't normally post these but I thought this one was particularly interesting considering his short position in treasuries.


Buy Cheap Bonds with Safe Spread
​Rather than outright default, many countries attempt rather successfully to keep nominal interest rates lower than would otherwise prevail.
Over the long term, this “financial repression” results in a transfer of wealth from savers to borrowers.

Investors shouldn’t give their money away, and at the moment, the duration component of a bond portfolio comes close to doing just that – because it doesn’t yield enough relative to inflation.

Because the QEs cover an extraordinary period of monetary policy with a limited time frame, there is not enough data to indicate whether the end of QEII will lead to higher or even lower rates, although higher is our strong preference. “Who will buy them?” remains a critical question to be answered. There is, however, overwhelming evidence – now provided by Carmen Reinhart among others – that existing Treasury yields fail to adequately compensate investors for the risk of holding them, when measured on a historical basis.

I’m going to one-up Mark Twain in the quantity department and spin two yarns about jumping frogs, one which has been frequently told, the other not so much. Neither of them have anything to do with Samuel Clemens’ heralded short story, but both, metaphorically at least, describe our current investment markets and how to think about the future. My first story is the one you’ve all heard about. Put a frog in a kettle of boiling water and he’ll jump out faster and further than any of those blue ribbon winners at the Calaveras County jumping frog contest. Put him in a pot at room temperature, however, slowly turn up the temperature to boiling, and you’ll have frog legs for dinner. This latter, more unfortunate toad temporarily adapted to his external environment, which seemed like a practical thing to do, until – well, until he reached 212° at which point he was cooked.

Today’s bond investors are experiencing a similar fate with nary a “ribbet” of complaint. “Total returns” for the first five months for almost all bond categories show positive price performance, which when combined with coupon interest income, produce portfolios 3% or so higher in value than at year-end 2010. That number may not match stocks or some of the high-flying commodities, but its annualized total return of 6½ –7% beats inflation however you want to measure it – core, headline or median CPI. Well – as I frustratingly tried to explain to my mother for years – this total return concept of price and yield appeals primarily when yields come down and bond prices go up. Think of bonds, Mom, as you would a teeter-totter, I would say. Interest rates go down – bond prices up. Vice versa too, except that beginning in 1981, the totter rarely teetered in the negative price direction. Bull markets in bonds, stocks and real estate rode an asset appreciation escalator that induced an artificial euphoria on the part of many investors expecting the ride to never end. Even conservative old-fashioned bonds – more famous for “coupon clipping” than capital gains – were bolstered by this secularly positive, total return concept.

Well, much like the Tower of Babel, Treasury bond prices cannot be heaven bound but have more earthly limitations. While stock values are often complicated by growth rate assumptions and P/E ratios making their ultimate destination uncertain, bond yields at least have a mathematical zero bound below which they cannot journey for more than a few nanoseconds. Investors don’t give up their money for the promise of less money in return and so negative nominal yields are a mathematical impossibility aside from fears of government confiscation and temporary liquidity considerations. But here is where it gets tricky and where our soon-to-be-boiled frog comes into play. Much like gradually turning up the temperature on poor froggy’s kettle of water, monetary policy in developed countries has been lowering the temperature and absolute level of yields for the past 2½ years post Lehman Brothers. Teeter-totter yields down, teeter-totter prices up, and froggy’s total return euphoria at present seems to know no bounds. But once the potential for even lower interest rates is minimized by the zero floor, our future frog-legged entrĂ©e is left with a rather uncomfortable feeling. He’s resting inertly in this caldron as prices near the boiling point with the Fed, the Chinese and the banks all buying up whatever Treasury bonds are offered. Everything appears well. But bond investors with a survival instinct (being one and the same as our cooking frog) should reflect on that old teeter-totter metaphor and realize that prices near the boiling point automatically imply yields near subzero. Granted, 5-year Treasury rates near 1.70% are not zero and 10s and 30s are even better, but much of the Treasury yield curve now rests in negative territory when compared with expected future inflation, and that should send our bond investor into a hoppin’ funk. Prices are already nearing the boiling point and his coupons are subzero, CPI adjusted. Total return…and our frog…are cooked, or if not they are certainly trapped in a future low return kettle of water.

Carmen Reinhart and coauthors writing for the National Bureau of Economic Research have exposed this dilemma in more sophisticated prose. In her second research paper, entitled “The Return of Financial Repression,” she affirms PIMCO’s thesis of skunking, pocket-picking and frog cooking by describing a century-old policy maneuver used by governments facing a debt crisis. Rather than outright default, many countries attempt rather successfully to keep nominal interest rates lower than would otherwise prevail. Reinhart characterizes this as “financial repression” because over the long term it results in a transfer of wealth from savers to borrowers. Governments, having taken on too much debt, rather stealthily lower interest rates via central-bank-enforced policy rates or maneuvers such as “quantitative easing.” The artificial yields, in effect, act as a tax on savings, undercompensating asset holders and transferring the haircut benefits to the debtor nation. Coincidentally (and certainly serendipitously), corporate and some household balance sheets are re-equitized as the negative or historically low real interest rates allow economic growth, profits and some wage earners to build up a margin of safety for future expansion.

Chart 1 shown below is graphic evidence of Reinhart’s financial repression over the past century, comparing two repressive periods (1945–1980 and 2008–2011) to a more normal interest rate environment without artificial government yield dampeners (1981–2007). Both periods of repression show bell-shaped curves shifted markedly to the left, with today’s current cycle offering 2½% less yield for the average G-7 nation than what bond investor frogs have gotten used to since 1981. Actually, in the U.S., May’s month-end estimate for real Treasury bill yields shown in Chart 1 would be 5% less than what Reinhart shows as the average compensation for the last 30 years!

All right fellow frogs, so we’re being repressed and shortchanged in order to allow Uncle Sam to balance its books. Whatta we gonna do about it? “Frogs of the world unite,” as Lenin might have said, and so here’s where I harken back to Mark Twain and my second lesser-told frog story. There was this other frog who instead of being tossed into a pot of hot water was left to cool its heels in a pitcher of cold milk. Unable to jump out, he churned and churned those frog legs until eventually the milk turned into butter and the hardened butter allowed him the platform to leap to froggy freedom! Well, let’s get churnin’, fellow frogs. If the U.S. or the U.K. or any other government is going to attempt to boil us alive, let’s make butter! Butter in this instance is what PIMCO characterizes as “cheap bonds.” Potentially confusing, “cheap bonds” is really a simple concept – sort of like the teeter-totter. Any bond, even a Treasury bond, is composed of several pieces – sort of like an atom with its neutrons, electrons, protons, positrons, neutrinos (whoops, don’t wanna go too far here). There’s an interest rate or yield piece, commonly measured by “duration.” There’s a credit piece, typically referred to as a “spread” when you buy a corporate bond. And there’s a volatility piece, a liquidity piece and other little bits and particles that will go unexplained for now. The important point, though, is that if the government is going to artificially repress yield, then an intelligent frog should focus on the parts of a bond that are less repressed! You can, for instance, produce a 1% expected return in today’s market in a number of ways. Buy a repressed 3-year Treasury note at just under 1%, or purchase an A-rated corporate floating rate note (FRN) with little to no durational risk at a 3-month LIBOR +75 basis points spread, currently returning 1%. Which is the better deal? Well, they both appear to lead you to the same place but our cheap bonds argument would maintain that the FRN gets you there with a lot less risk. The credit piece, in other words, is a safer spread than the duration piece.

Journalists, financial advisors, and perhaps even some clients marvel at how PIMCO can be doing so well in 2011 while being underweight the Treasury/durational component of the bond market. Folks – we're making butter. If you’re being repressed, our strategy is to churn those legs, get out of the pitcher, and above all stay away from boiling pots of water. Recent press coverage has focused on the end of QEII and what it may or may not do to Treasury prices. Let me reaffirm what we’ve said for many months now. Because the QEs cover an extraordinary period of monetary policy with a limited time frame, there is not enough data to indicate whether the end of QEII will lead to higher or even lower rates, although higher is our strong preference. “Who will buy them?” remains a critical question to be answered. There is, however, overwhelming evidence – now provided by Carmen Reinhart among others – that existing Treasury yields fail to adequately compensate investors for the risk of holding them when measured on an historical basis.

We suggest buying “cheap bonds” focusing on “safe spread,” which means buying more floating and fewer fixed rate notes, adding an additional credit component – be it investment grade, high yield, non-agency mortgage or emerging market related – and shading your portfolio in the direction of non-dollar emerging market currencies. Investors shouldn’t give their money away, and at the moment, the duration component of a bond portfolio comes close to doing just that – not because a bear market is just around the corner come July 1, but because it doesn’t yield enough relative to inflation. Come on frogs, make butter, not someone else’s dinner. Buy cheap bonds!

William H. Gross
Managing Director