Bill Gross, the investment chief at the bond giant PIMCO, is out with his monthly musings on the bond market. The piece - which is available here - features some sound advice for investors who are concerned about whether corporate and high yield bonds are in a bubble.
Opening with a discussion about the challenges of judging when markets have become "irrational," Gross says about the credit markets (i.e., corporate and high yield bonds), "On a scale of 1-10 measuring asset price 'irrationality', we are probably at a 6 and moving in an upward direction." In other words, the markets are somewhat frothy, but they're not at the level of extreme irrationality that would indicate a bubble.
Gross goes on to discuss the massive inflows into the credit markets during the past year, along with the surge in new issuance of high-yield bonds. Still, he says, "Corporate (bonds) and high yield bonds are somewhat exuberantly and irrationally priced. (Yield) spreads are tight (meaning yields are low relative to Treasuries), corporate profit margins are at record peaks with room to fall, and the economy is still fragile. Still that doesn't mean you should (eliminate them from your portfolio). It just implies that recent double-digit returns are unlikely to be replicated and ... that 3-4% realized returns are the likely outcome." All parentheses are mine.
In short, Gross is urging investors - as he phrases it - to "lower return expectations, not to abandon ship." It's wise advice, and it echoes what appeated in our 2013 Bond Market Outlook. The bottom line: there's no reason to panic, just recognize that the big returns from years past are highly unlikely to be replicated.