When I first began reading this month’s missive from Pimco Total Return Fund’s (PTTRX) Bill Gross, I thought he was going in a Johnny Cash direction, playing with a theme built on Cash’s 1963 hit record, Ring of Fire, which, paradoxically, was about falling in love. But I was wrong. Instead, Gross was writing about national debt and the ‘ring of fire’ analogy comes from this section in his latest Investment Outlook [emphasis added]:
The Ring of Fire (PIMCO, Feb. 2010, Bill Gross)
…The most vulnerable countries in 2010 are shown in PIMCO's chart "The Ring of Fire." These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years' time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth…
Source: Pimco
The chart has a nicely lurid look and feel to it. Ask yourself, would you like to be in the cool green or yellow areas or the one with flames? Despite the cheesy graphics, the point being made is important. Gross is pointing out that there is a limit to how much debt even sovereign governments can properly finance.
Lately, Greece has been in the news for its high level of government debt and likely need for a bailout from other EU countries. However, if you look at the chart one country jumps out as being way out there — even further than Greece — and that is Japan.
I won’t go into all the issues with Japan (see S&P warns it may downgrade Japan), but there is a pretty good argument that it is vulnerable, at minimum, to some form of interest rate shock because interest rates on Japanese government debt are very low.
Gross goes on to recommend investing in Canada and Germany and to avoid the U.K.:
…Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada. Its conservative banks never did participate in the housing crisis and it moved toward and stayed closer to fiscal balance than any other country, 2) Germany is the safest, most liquid sovereign alternative, although its leadership and the EU's potential stance toward bailouts of Greece and Ireland must be watched. Think AIG and GMAC and you have a similar comparative predicament, and 3) the U.K. is a must to avoid. Its Gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2 % and lower…
Nitro & fire…
British government bonds, gilts, are ‘resting on a bed of nitroglycerine? And, the UK is well within the ring of fire? Even I get that one — nitro and fire — a very bad combination.
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Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.
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