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A BOND GURU PEERS INTO THE FUTURE

Led by Bill Gross, Pacific Investment Management in Newport Beach, Calif., is the nation's leading bond investor, with some $100 billion in its portfolio. Gross, who manages the PIMCO Total Return series of funds, discussed the outlook for bonds with Senior Writer Robert Barker in mid-July, as the yield on long-term Treasuries was sinking below 6.5% for the first time this year.

Q: What's your forecast for interest rates?
A: My sense is still a 6% target by yearend. I think the market is beginning to believe that we're in a 2% inflationary world, and maybe even less, and if that's the case, then long bonds represent a 4.5% real return.

Q: Is 6% a floor?
A: I think it's a floor unless we get a recession. Then rates could fall as low as 5%, but that would be a cyclical low--6% represents a median level around which the market will fluctuate.

Q: Are corporate bonds overvalued?
A: Very much so. All we need is a mild recession, with a credit crisis here or there, to put a little fear into the market to make corporates most unattractive. Junk bonds would be even worse. It was 1990 or 1991 when we had our last crisis with the banks, and people tend to forget. Even if I'm wrong, and the recession never comes, the fact is, in this Goldilocks corporate environment [meaning not too hot, not too cold--but just right], you're only getting half a percentage point in yield over and above a Treasury.

Q: Do you own any junk bonds?
A: We have a few, but they tend to be very short [duration], like two- to three-year paper. We have some Time Warner, which we think of as pretty high-quality junk.

Q: How else can you get extra yield?
A: By buying longer-term Treasuries and mortgage-backed bonds.

Q: What's the minimum an individual needs to build a bond portfolio, as opposed to buying funds?
A: That's a tough one, but I'd say at least $100,000 to diversify enough in corporates and Treasuries. In mortgages, it would be higher, maybe $500,000.



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