Tracking the Bond Market on Rail Traffic

Should investors listen when a one-time professional blackjack player says he uses freight rail traffic to chart the direction of interest rates?

What if that former Las Vegas card counter ran $90 billion worth of bonds and was named Bill Gross?

Thirty-one years after leaving the gambling halls to join the Navy and later manage money, Gross, now managing director at Pimco Advisers LP, carries a lot of weight in the bond market.

With that kind of money under his management and with a winning track record, Gross has been called the “Peter Lynch of bonds.” He was linked to the former Fidelity Magellan Fund stock picker when he came to share one preeminent trait--a gift for calling the pace and direction of markets.

Pimco’s flagship Total Return bond fund returned an average 8.39% a year in the five years ended July 31, according to Lipper Analytical Services Inc. That won it first place among 57 funds with similar objectives, Lipper said.

So it might be of interest to know where Gross turns when he becomes perplexed about where interest rates and the economy are headed. He finds his clues in some unlikely places--not only a little-noticed figure such as rail shipments, but also in raw steel production and even the help-wanted ads.

“I try to look for anything the market isn’t looking at,” said Gross, 53, who lives in Laguna Beach with his wife, Sue, and youngest son, Nick. He also has two grown children, Jeff and Jennifer.

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Gross follows weekly freight rail shipments--put out each Thursday by the Assn. of American Railroads--as a measure of the economy’s strength. His thinking is that robust manufacturing only spurs growth when goods are shipped and sold.

“If it’s not shipped, it’s not going to be bought,” said Gross, explaining his fondness for the report, which has also been a favorite of Federal Reserve Chairman Alan Greenspan. “If you don’t ship goods, it’s certainly not an indication of economic strength.”

Gross watches the average of the most recent five weeks of shipments, comparing it with the average for the past 52 weeks.

“The market doesn’t move on that number, and it tends to be forgotten, but it’s a decent number,” Gross said. Rising shipments of raw materials also point to greater economic strength, because it means manufacturers need more supplies to make finished goods.

Of course, Gross doesn’t ignore widely watched figures like the government’s monthly jobs report, the consumer price index or commodity prices. Gross, a marathon runner, also takes a three- to five-year view when placing his big bets, and he says a few of the less-noticed indicators give him a jump on charting the direction of the economy and bond yields.

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Among other narrower, yet telling, data is the American Iron and Steel Institute’s report on raw steel production at the nation’s mills, released each Monday afternoon, Gross said. He tracks the figure by comparing the four-week moving average with the average for the past 52 weeks.

Gross likes this report because it’s rarely influenced by strikes--unlike other jobs and production figures. What’s more, because steel production isn’t seasonal, Gross can use the numbers to track the year-round strength of the industry. The numbers also give Gross an early take on the economy, since they come out at the beginning of the week.

To be sure, raw steel numbers don’t provide much help in charting service industries such as financial management, consulting or health care, which have become a bigger part of the economy. Yet swings in steel production tend to match the ebb and flow of industry as the economy surges and slows.

“I found over the years it’s a pretty good indicator,” Gross said. “It gives a sense of the short-term direction of the economy.”

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For similar reasons, Gross pays close attention to a private weekly retail sales report each Tuesday morning by the Bank of Tokyo-Mitsubishi/Schroder Wertheim. The figure provides up-to-date information on consumer demand and spending, which make up about two-thirds of the economy.

Like the raw steel numbers, the Mitsubishi report comes out early in the week. At the same time, like the rail figures, it doesn’t typically cause big market swings.

“It’s a pretty good early lead in a Tuesday morning in terms of consumption,” said Gross.

For clues on the strength of the jobs market, Gross scans a monthly index of help-wanted advertising.

An increase in the index--culled from a survey of 51 major newspapers by the New York-based Conference Board--means there’s a scarcity of workers to fill available jobs, which could push wages higher and spur inflation. A decrease means businesses don’t need as much extra help, suggesting that the economy’s not overheating.

“The help-wanted index tends to be a good leading indicator for demand for wages and pressure for the markets,” Gross said.

He also tracks the total number of workers collecting state unemployment benefits--a less-noticed number within the government’s weekly Thursday report on jobless claims--for a sense of the labor market’s strength.

Gross’s core belief--that yields on government bonds will drift lower in the months ahead and trade in a narrow range in the next several years as inflation stays subdued--is based on fewer trade barriers, declining federal budget deficits, global competition and a strong dollar.

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Right now, Pimco has the bulk of its holdings in mortgage-backed bonds, which tend to perform better than Treasuries when yields are steady. Mortgages will perform better than most other fixed-income investments over the next several years if, as Gross expects, yields on benchmark 30-year Treasuries drift in a range of 5% to 7%, he said.

“My thesis is, ‘It’s different this time,’ ” Gross said. He even wrote a book--”Everything You’ve Heard About Investing Is Wrong!”--to herald what he sees as a new era of low inflation and moderate returns on both stocks and bonds. For Gross, a long-term view of the markets is one of the keys to his success.

Gross still makes trades to take advantage of short-term swings in the market and economy. He sold some of his Treasury holdings earlier in the year as the economy surged, yields climbed and the Federal Reserve boosted bank lending rates. In recent weeks, he bought about $1 billion of Treasury bonds amid expectations that yields will fall as low as 6% by year-end as the dollar remains strong and inflation stays subdued.

“The day is full of numbers,” Gross said. “Those types of numbers that the market doesn’t tend to focus on are the ones I tend to look at.”