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Bill Gross: It'll take a war to save bond investors

Jeff Brown, Special to CNBC.com
Thursday, 8 Aug 2013 | 4:34 PM ET
Andrew Harrer | Bloomberg | Getty Images

Recapping the day's news and newsmakers through the lens of CNBC.

Bill Gross's last stand?

Notes:

Everyone knows higher interest rates are coming; no one knows exactly when.

And that uncertainty, based on confusion about the Federal Reserve's tapering plans, has added some fear to bond investing. Always eager to make the case for bonds—and in the aftermath of a major exodus of assets from his bond giant's funds—Pimco chief Bill Gross invoked war metaphors in his latest letter to clients.

As most savvy investors know, when interest rates rise, prices of older bonds fall. After all, who'd pay full price for an old bond yielding 3 percent if a new one paid more? At some point, investors' expectations about higher yields in the future are baked into current prices. But when expectations prove premature or wrong, prices have to adjust, making for the kind of drama we are seeing play out in the bond markets. Investors have pulled tens of billions out of bond funds, but that's just a drop in the bucket, and a bigger exodus could be very disruptive, hammering bond prices.

Amid all this commotion, Gross has a simple view of the bottom line: he says investors should prepare for a world of lower bond returns. So why own bonds at all in this environment? Gross says bonds still offer diversity, and Pimco still has some tricks up its sleeve to make bond investing work. Investors can still make more with bonds than with cash, and if they assume yield is all they'll earn, and they are not speculating on prices, bonds entail less risk than stocks.

Appearing late in the day on CNBC, Gross toned down his rhetoric and said the war he was referring to might not be on the scale of World War II.

Quotes:

"Bonds have suffered a near Somme-like defeat in the past few months...We have spent months—indeed years—preparing for this new dawn. We intend for you—our clients—to be surviving veterans of this battle, not casualties."
—Bill Gross

"It's not like the Cuban missile crisis or a nuclear war. It's more like Grenada in terms of what we've gone through."
—Gross, referring to the U.S.-led invasion of the tiny Caribbean island nation in 1983, which resulted in a U.S. victory within a matter of weeks.

"Every time the Fed has enabled a liquidity-fueled surge in asset prices, eventually you had a great unwind. ...That could be very disruptive to both interest rates and credit spreads."
—Jurrien Timmer, Fidelity's director of global macro

Jason Homa | Image Bank | Getty Images

Plastic phobia: a fear of high-interest credit

Notes:

Consumer spending, as we've been told time and time again, accounts for about 70 percent of economic activity. So, if you want the economy to grow faster, you want consumers to spend more, and that typically means borrowing more.

Well, they are borrowing more, but the news is a mixed bag. Consumers increased borrowing by $13.8 billion from May to June, to a seasonally adjusted $2.85 trillion, a record. But the borrowing category that includes credit card debt fell by $2.7 billion, and remains about 16.5 percent below the record set in 2008.

The biggest gains in borrowing are for vehicles and student debt. Rising vehicle purchases definitely boost the economy. But student debt...Well, over time that may turn out to be more of a hindrance than a help. Surveys have shown that young people burdened with student debt plan to postpone big-ticket purchases like homes and cars.

Consumers reluctance to spend and rack up high-interest card debt is also evident in lackluster results from retailers. To keep sales up, many retailers have resorted to discounts. That, of course, can hurt earnings and steal from future sales.

Quote:

"Consumers need a reason to go to the store. It's consistent with what we've been seeing from economic data: The recovery is sluggish."
—Barbara Kahn, director of the Wharton School's Jay H. Baker Retailing Center

An employment sign is placed in the window of Banana Republic clothing store on June 21, 2013 in Pasadena, California.
Getty Images
An employment sign is placed in the window of Banana Republic clothing store on June 21, 2013 in Pasadena, California.

But all is not gloomy

Notes:

Okay, so unemployment claims were up a tad last week. The important thing is the trend looks pretty good.

The Labor Department said initial unemployment claims rose by 5,000 to 333,000, a tad better than the 336,000 economists had predicted. Most importantly, the four-week average fell to its lowest level since November 2007, the eve of the recession. The four-week average is a better gauge than weekly figure.

Most data shows the U.S. economy doing fairly well, and that may show up soon in stronger growth in gross domestic product.

Quotes:

"It's more good news. If you look at the labor market in general, every indication we have in the labor market is that it's doing reasonably well...Basically, every data point except GDP is showing the U.S. doing very well."
—UBS economist Drew Matus

Getty Images

A rich wallflower at the punchbowl

Notes:

Poor Fannie Mae. She comes to the ball in a $10 billion gown, and no one asks her to dance.

Today, the mortgage giant reported a stunning $10.1 billion second-quarter profit, about double the year-ago figure. But just about everyone—Democrats, Republicans, President Barack Obama—wants to shut the company down. If politicians of various stripes have one thing in common, it's the ability to hold a grudge.

No one has forgotten how Fannie and her cousin Freddie Mac, which reported a $5 billion profit Wednesday, came hat in hand for a taxpayer bailout. And no one wants to ever have to do that again. On the other hand, today's big profits are hard to ignore, with Fannie about to funnel $10.2 billion to the U.S. Treasury, bringing those contributions to $105 billion. In face of that, shuttering the mortgage-financing firms will be no easy task.

Want to get in on this? Sorry, Fannie's shares are still next to worthless, because it's not likely the firm will ever again be a freestanding public company.

Quotes:

"This strong quarter was driven primarily by continued stable revenues, and boosted by a significant increase in home prices in the quarter, which resulted in a reduction in the company's loan loss reserves... Delinquencies on Fannie Mae's books are still high, but, again, improving home prices are helping that."
—CNBC's Diana Olick

"Any reform of the housing finance system will take a number of years to achieve. We would expect to continue to be focused on returning as much value to taxpayers in the meantime."
— Fannie Mae CEO Timothy Mayopoulos

Tesla Model S
Source: teslamotors.com
Tesla Model S

New economy high flyers: Tesla, Groupon

Notes:

One of the toughest challenges for investors is to properly interpret the point when splashy IPOs tied to "new economies" hit the sustainable profit mark.

Take Tesla and the electric car market. Not long ago one of the most-shorted stocks in the market, Tesla is now up 350 percent this year and at an all-time high stock price. During the summer of 2012, when the stock was in the high $20s, CEO Elon Musk remarked that the short investors were in for a world of pain. Boy was he right.

Shares in the electric sports car maker jumped as much as 18 percent to a record high on Thursday, after surprisingly strong second-quarter results convinced investors the company has found a route to sustainable profits.

Then there's Groupon, linked to the up and down—lately, mostly down—daily deals space. After firing its CEO and being left for dead, Groupon shares were up more than 20 percent on Thursday and touched a 52-week high. New CEO Eric Lefkofsky told CNBC that the company will remain focused on several core strategies—migration to mobile, the transition from being a daily email service to "a true e-commerce marketplace" while looking to apply successes in North American markets to operations across the globe.

Lefkofsky said that part of the "playbook" for growth abroad is to bring more deals and to present Groupon as a starting place for consumers, instead of an ancillary shopping destination. He added that mobile growth overseas is expanding faster than in North America, where nearly half of the business is done on mobile devices.

Quotes:

"The bull argument for the stock could be that the CEO, Elon Musk, is the next Henry Ford—i.e. mass market success would be assured."
—Barclays Capital analyst Brian Johnson

"Honestly, I hadn't heard it until now. My first reaction: I was in a school play and I sung this Kermit the Frog song—something about a rainbow—Rainbow Connection, I think in sixth grade or something. That was my first reaction."
—Groupon CEO Eric Lefkofsky on the album recently released by Andrew Mason, Groupon founder and its first CEO, whom Lefkosfsky replaced

—By Jeff Brown, Special to CNBC.com

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