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October 23, 2000

Fund Manager Urges Retreat From Corporate Bonds
By Joshua Chaffin, The Financial Times

Run -- Don't Walk -- Away From Corporate Bonds ... Weiss comments

NEW YORK - The largest bond fund manager in the world is warning investors to avoid corporate bonds at all costs.

William Gross, managing director of Pimco, the Allianz-owned US fund manager, fears the US economy is heading for hard landing and says the current environment for the fixed income markets is the most uncertain he has seen since he began trading in the 1970s.

"Spread product [corporate debt] is in for some grim reapings in the next month and the next few quarters," said Mr. Gross, whose fund manages about $200bn in assets, and is considered the most influential in fixed income markets.

The fund manager's comments, at a New York dinner, have added to the considerable gloom that has descended on the corporate bond market in recent weeks. It has been hit by falling share prices and concerns that the economy's growth may be slowing more than expected as default rates rise.

Corporate bond spreads have widened dramatically in a variety of sectors as a result, drawing comparisons from some analysts to the crisis that swept credit markets after Russia's default in late 1998.

"There is a fear that if a company has even a slight misstep, then it will be punished by investors," said Michael Materasso, of Fiduciary Trust International.

Mr. Gross has recently moved much of his portfolio into mortgage-backed securities, such as debt from Ginnie Mae, the home lending agency. Such bonds offer higher credit quality than corporate debt, and higher yields than traditional Treasury bonds.

Mr. Gross predicted corporate bonds would continue to struggle amid a cyclical slowdown, and cautioned that one of the main risks to the economy was that Alan Greenspan, chairman of the Federal Reserve, might wait too long to loosen monetary policy.

He added that corporate bonds were vulnerable to a revival of growth as more companies issue debt to compete in volatile technology industries.

The outlook for corporate bonds is frightening. Companies, mostly technology companies, have released a deluge of corporate bonds on the market to finance their expansion. Swapping debt for equity on their balance sheets allowed these companies to report better earnings. However, this practice has caused an oversupply of junk bonds in the market and pushed spreads to dangerous levels. Plus, as several companies have reported earnings well below estimates and forecast future disappointments, investors are fleeing corporate bonds in droves.

The bond market has already priced in a high probability that many companies will default. The spreads for corporate bonds are higher now than they were at the time of Russia's default on its domestic debt and the Long-Term Capital Management crisis in 1998. And it's going to get much worse. The U.S. economy is headed for a very hard landing. A severe slowdown in the U.S. economy will certainly cripple companies' ability to pay the interest payments promised to investors. We've already seen a number of internet companies file for bankruptcy protection in recent weeks. Furthermore, the euro has strengthened somewhat since the ECB intervened on its behalf. With a worldwide slowdown emerging, European investors are finding it easier to keep their cash at home rather than investing in U.S. junk bonds. In addition, the vicious cycle will continue as technology companies struggle to keep afloat by issuing even more debt. Don't get sucked into this. Corporate bonds, even those issued by those outside of the technology sector, are a bad idea right now.

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