Stocks and bonds is the smart way

This may be the best news for stocks in a long time: Bill Gross, who manages the world's biggest bond fund, says the 30-year bull market in fixed-income securities is ending.

Though Gross, who runs Pacific Investment Management Company's $214 billion [Dh786bn] Pimco Total Return Fund, would never tell you to buy stocks, isn't that what he means?

Pimco, which Gross co-founded, more or less said as much in December. It announced the Pimco Global Opportunities Fund, which will invest in stocks, though it also will buy bank loans, junk bonds and distressed securities. Stocks should be due for better times after a decade that featured the dot-com crash followed by the more recent Wall Street-induced credit crunch. The market certainly has picked up in past 12 months.

The benchmark Standard & Poor's 500 Index is up more than 70 per cent from its recession low a year ago this month.

Stocks have improved along with the American economy, which grew 5.6 per cent in the fourth quarter as corporate profits jumped eight per cent.

Favourable news continues. Shares of US Steel, a backbone-industry company, have climbed almost 50 per cent since February 4. Apple, maker of iPods and iPads, may hit $300 from its current price of about $232, Credit Suisse Group said.

Starbucks, the ubiquitous coffee-shop chain, last week announced its first dividend as a public company. Takeovers are heating up, boosting prices of target companies. Prudential and MetLife will pay a total of $51bn for insurance assets of US Government-controlled American International Group.

Contrarians might sense that a long run for stocks is coming. At least until Gross spoke, investors were pouring money into bond funds, thinking first about safety after the most recent stock market debacle – and, of course, missing the recent spurt in shares.

So far this year, investors have placed about $89bn with bond managers, according to Emerging Portfolio Fund Research. That was about five times the rate in the first quarter a year ago. If investors sour on bonds, that amount of money will funnel into stocks.

Bond investors are nervous because interest rates are rising, reducing the market value of their securities. The yield on the benchmark 10-year US Treasury note stood at 3.86 per cent yesterday, up from about two per cent in December 2008.

Rates reflect the flood of Treasury bonds being sold to cover the US budget deficit, which hit $1.4 trillion in fiscal 2009. Investors also worry about the inflationary effect of increased government spending.

Higher interest rates and increased inflation can hurt stocks too – eventually. But that day may be a long way off while rising yields and falling bond prices are here and now.

Full disclosure compels me to say that in even saying the words "bull market", I'm talking my own book. My investments are in stock mutual funds. Smart people have a balance of stocks and bonds.

A new lucrative era for stocks may be a pipe dream. High US unemployment may portend a worsening economy and lower stock prices.

While Gross is giving stocks an indirect plug, he's still buying bonds. He recommends, for instance, longer-term securities of Germany and Canada, whose governments are more frugal than that of the US Pimco's $1trn or so of assets are still overwhelmingly in bonds.

Let's wait to see if Pimco makes an even bigger splash in stocks.

- David Pauly is a columnist for Bloomberg News. The opinions expressed are his own

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