Bill Gross: investors still going for 'cleanest dirty shirts'

The ‘dysfunctional family’ feud gripping the eurozone and its global effect on markets means the only real opportunities are in emerging markets but bond investors still won't admit it, says bond veteran Bill Gross.

In his latest market outlook, the manager of the world’s largest bond fund, the $244 billion Pimco Total Return Fund, said investors should recognize the euroland’s problems are global and secular in nature - and look towards emerging markets bonds.

‘It will be years before euroland, the United States, Japan and developed nations in total can constructively escape from their straitjacket of high debt and low growth,’ said the outspoken manager.

In order to get long-term returns of 5% from either stocks or bonds, says Gross, there is only really one way to turn.

‘To approach those numbers, risk assets in developing as opposed to developed economies should be emphasized. Consider Brazil with its agricultural breadbasket and its oil. Consider Asia with its underdeveloped consumer sector but be mindful of credit bubbles.’

Despite this, he believes that bond investors will favour the strategy of locating the ‘cleanest dirty shirts’, such as the United States, Canada, United Kingdom and Australia.

‘Investors will focus on a consistent “extended period of time” policy rate that allows two- to ten-year maturities to roll down a near perpetually steep yield curve to produce capital gains and total returns which exceed stingy, financially repressive coupons.’

‘A 1% five-year Treasury yield, for instance, produces a 2% return when held for 12 months under such conditions. Bond investors should also consider high as opposed to lower quality corporates as economic growth slows in 2012.’

The outlook for global and developed economies is rather bleak, he added, with the eurozone continuing to show the failings and vulnerability that has come to characterize the region in the past few months.

‘It will remain a dysfunctional family no matter what the outcome. You can’t tell a German much, and while they can issue what appear to be constructive orders and solutions to the southern peripherals, there is little doubt that none of them will “like it very much.”'

‘Slow/negative growth and historically wide bond yield spreads will therefore likely continue.'

‘Globalized markets themselves will remain relatively dysfunctional, pointing towards high cash balances in presumably safe haven countries such as the United Kingdom, Canada and the United States. The US dollar should stay relatively strong, ultimately affecting its own anemic growth rate in a downward direction.'