Three Gross Mistakes

Steve McDonald By Steve McDonald, Bond Strategist, The Oxford Club

Bond Investing

Way back when – I jokingly call it the period in my life when dead wasn’t forever – I used to fly helos and fixed-wing aircraft for the Navy.

Now, naval aviation is not in and of itself a dangerous profession. But it is horribly unforgiving if you screw up. I know the media makes it look like every flight is death defying, but it isn’t, not if you stick to the tried and true procedures.

During my flying time, I had three significant emergencies… an engine failure in a single-engine aircraft, a cockpit fire and another engine problem that, if I didn’t get it out of the air in a hurry, would have been another engine failure.

Any normal person, after the first forced landing in a field in northwest Florida, would have found another way to earn a living. But my reaction was just the opposite.

I never said I was smart.

Each emergency increased my confidence in the emergency procedures we had drilled into us. In fact, with each thrill ride, I felt like I gained confidence in myself and in the fact that these tried and true procedures really do work.

They will keep you alive.

These procedures are called NATOPS (Naval Air Training and Operational Procedures Standardization). They cover just about every onboard system and emergency procedure necessary to fly an airplane safely.

As the saying goes, NATOPS is written in blood. You better believe it is!

The F/A-18 NATOPS manual is about 3,500 pages long and, if you plan to live to a ripe old age, you had better know every procedure by heart and live by them.

Get cocky and overconfident in your abilities or do something stupid and you have a very good chance of going home dead.

The same is true for the money business, but thankfully, the rules here aren’t quite as numerous or as rigid as aviation’s. But, just as in flying, there are some rules that are cast in stone. And if you break them, while they won’t kill you, not immediately anyway, they will deliver a painful experience.

The first rule you never break is never time the markets. This is one of the most common errors and it usually takes several very big losses to finally realize that no one can do it successfully. No one!

The second is never confuse a bull market with brilliance. This is the one most of us have fallen prey to at least once in our careers. When the bulls are running, it is easy to believe you are a market genius, when in fact it is just another bull run.

The third rule is it is not different this time. It is never different. A market may look like it has changed, but no matter what the recently dubbed market geniuses say, it never changes.

Well, several years ago, Bill Gross, the bond king and the (former) infallible manager of the largest bond fund in the world, ignored all of these rules and the outcome was as predictable as it always has been.

His mistake started when he decided to time the bond market – Treasurys, to be more specific. He believed it really was different this time and you could time this market. It seemed so obvious.

The Treasury market was at the end of a multidecade run-up in price and had to correct, and very soon.

Of course, the money press was behind his call 99.999%. Almost every person in the money business believed what Bill was doing was the right call. Almost everyone said that bonds were dead, about to get deader and you had to get out of them.

Gross’ kiss of death, the one that makes all the errors possible, was he made the mistake of believing he was the market genius everyone said he was.

Well, as so often happens when you cross the time-proven lines, the blade fell right on the Bond King.

Almost immediately after Gross’ decision to sell all the Treasurys in his Pimco fund – and he sold all of them – the unimaginable happened.

Treasurys ran up in price. A lot higher! The price increase drove the yield down on the benchmark 10-year to an unimaginable 1.66% and 1.35% intraday.

Think Bill was just a little embarrassed? Not really, he was the king and he, and almost everyone else, knew it was a fluke.

It was no fluke.

Following the sale of all his Treasurys, his fund’s returns plummeted and withdrawals hit record highs. The king was bleeding money.

Here we are about a year and a half later, and the 10-year is still paying only 2.5%. And now, the real bond experts are beginning to realize we may be in this depressed yield market for longer than anyone thought possible.

Mr. Gross very well could be the bond genius he has been called. But he ignored all the time-proven procedures that served him so well for so many years and stepped over three of the few well-marked and well-respected lines in the markets.

This is where his slide started.

You can get lucky once in a while – once in a lifetime is a better description – but no one, not even the king of the bond market, can get away with timing the market.

No one is smarter than the market and it is never any different. Markets don’t change because people don’t change.

His slide from grace ended recently when he resigned from Pimco, the company he co-founded, to go to work for Janus Capital Group. The scuttlebutt is he was about to be fired.

You may be thinking, it’s easy to sit here now with 20/20 hindsight and tell everyone that he was wrong and why he was so far off base. But at the time, I was saying and doing the exact opposite of what the king was doing and taking a substantial beating from the rest of the money world for it.

Does that make me a genius? Hardly. But it speaks volumes about what sticking to the procedures can do for you.

Since the collapse of the markets back in 2008, I have told my readers to ignore all the predictions of the money press and to use the time-proven methods that have and always will make money and keep you safe in the bond market. They are:

  • Buy and hold good quality bonds.
  • Hold only ultra-short maturities of less than seven years.
  • Ignore market price fluctuations as they do not affect your returns.
  • Remember that as long as the company is in business, bondholders get paid.
  • And, worst-case scenario, short of a default, hold a bond to maturity.

Sticking to these time-proven rules and procedures has produced annual returns of as much as 42% a year since 2008. Gross’ long-term return is about 6%.

But, more importantly, it has kept my readers invested during a period when everyone, except a few bond heads like me, believed this time it was different, that you can time a market and there really are geniuses among us.

No matter how often the new geniuses of the current bull market say it, it is not different this time. It never is.

If you want to stay alive, stick with the rules that are tried and time proven. It’s worked pretty well for me for the last 35 years, and now for my bond subscribers.