By Evaldo Albuquerque, editor, Exotic FX Elite
How would you feel if Warren Buffet suddenly dumped all his U.S. stocks?
Buffet is arguably the best stock investor ever. So I know I would be concerned. I’m guessing you wouldn’t feel confident about your own stock portfolio either if “the Oracle of Omaha” completely eliminated his exposure to local stocks.
Of course Buffet isn’t doing that. But something just as drastic is happening in the fixed-income market.
Bill Gross, manager of the largest bond fund in world, has completely eliminated his exposure to U.S. Treasuries.
His fund now holds 0% of U.S. Treasuries.
I like to think of Gross as “the Warren Buffet of the fixed-income world.” His decisions are just as important. The fact that he doesn’t want to have any exposure to Uncle Sam’s bonds sends a critical message to the market.
And if you are searching for retirement income, his message is especially important to you…
“Don’t Be the Biggest Fool”
In 2007, investors were flipping houses for a quick profit. It didn’t matter if houses were grossly overvalued. As long as you could find someone willing to pay more, it made sense to invest in housing.
That’s a real life example of what’s called the “greater fool theory.”
According to this theory, an investor buys an overvalued asset because he hopes to sell it at a higher price to another investor, who’s planning to do the same.
That kind of selling from fool to fool can’t last. Eventually, rationality returns to the markets. Then, the last investor becomes the greatest fool who now owns an asset that’s about to plummet in value.
The same thing seems to be going on in the Treasury market right now. Who would lend money to the U.S. government for a decade for a mere 3.3% yield? Not many. Such low yields don’t compensate investors for the risk of inflation.
The chart above shows the tight correlation between bond yields and inflation.
When inflation rises, bond investors start demanding higher yields to compensate for the loss of purchasing power. If yields rise, any bonds you own today that pay lower yields will drop in value. It makes sense – everyone will want new bonds that pay higher yields.
In early 1980s, inflation forced yields as high as 15.8%. If we see a similar episode of inflation now, investors buying 10-year Treasuries today will suffer an estimated loss of about 61%.
By getting out of Treasuries now, Gross is making sure he won’t be the biggest fool.
The Message from the Bond King is Crystal Clear
The best fixed-income investor in history doesn’t want to touch U.S. Treasuries with a 10 foot pole. You couldn’t get a message clearer than that: stay away from them too.
You don’t have to be an investment genius to understand his reasons.
Unprecedented debt spending from the U.S. government and continuous money printing from the Fed are two very good reasons to stay away from U.S. Treasuries.
Those two factors will ensure the dollar’s long-term downtrend continues for the next decade (even if there are short-term bounces along the way).
But you don’t have to fall victim to the declining dollar and the loss of your purchasing power.
Where to Build Income for Your Retirement
From an investment perspective, Gross advice is to stay clear of “bonds in dollar denominated terms.”
So if Gross is selling Treasuries, where is he putting his money? Well, one of his favorite investments is bonds denominated in foreign currencies that pay higher yields. With those assets, you not only get a higher income, but you also diversify away from the dollar.
Personally, I prefer simply buying higher-yielding foreign currencies for the long-run. There are plenty of foreign currencies that pay much higher yields than Treasuries (yields as high as 22 times the lowest-paying Treasuries).
Also, holding foreign currencies helps protect your purchasing power – because these currencies are much more likely to rally against the dollar in the long-term.
Federal Reserve Chairman Ben Bernanke still believes inflation will be contained. Meanwhile the world’s best bond investor is dumping U.S. Treasuries and getting out of U.S. dollars.
Who would you rather believe: the man who’s debasing the dollar or the best fixed-income investor ever? I would listen to the Bond King if I were you.
Editor, Exotic FX Alert