Long Treasurys for the Short Run?

The S&P 500 index has for now held at the 150-200 day moving averages, and has reversed downward in early trading.  These moving averages are themselves moving downward, reflecting the downtrend in stock prices that has been in place for over half a year.  In combination with growing evidence of recession in major parts of Europe, Hong Kong and elsewhere, plus at best a growth slowdown in many other places, the outlook for commodities continues in my view to favor the bears; and though many stocks have “defensive” characteristics, stocks on average have been trading with commodities.

The beneficiary of this trend, should it continue, is the ultimate contrarian play I have been speaking well of since the spring, namely U. S. long-term Treasury bonds.  Note this is a speculative investment in my view, not due to problems with repayment in nominal dollars but because rates are so low and because of all the well-advertized issues with Fed policy, government deficits and all that sort of stuff you know well.  But because you know it so well and may recoil from it, all that stuff might be “priced in”, and at least allow for short-to-intermediate term additional yield declines.

The math of buying a 30-year zero coupon Treasury is as follows.  At today’s very low yield of 3.0%, it should be priced about 41.20 to yield 3% compounded annually for 30 years.  If instantaneously the yield were to fall to 2.5%, the price should be about 47.6.  (Both these prices are scheduled to return 100 at maturity in 2041.)  The % appreciation from about 41 to about 47 is about 15%.  There is some dealer commission here, as this is an OTC market.  This commission means that in reality, OTC purchases of zero-coupon Treasurys are terrible in-and-out trading vehicles.  But I have found them to be decent intermediate-term trading vehicles (weeks to months).  The much less leveraged long-term T-bond ETF known by its TLT symbol is conducive for trading, but as it deals with par bonds trading will above par, there is negative leverage to interest rate decreases inherent in TLT’s pricing (sorry, no time to run through the math), so at today’s high price for TLT, I totally ignore it as an investment vehicle. 

My general take on this is to use the Japanese experience, in which the zero bound for short-term interest rates exerted a continual “gravitational” pull on the longer rates.  At this point, the U. S. one-year Treasury bond (note, bill) yields a tiny bit less than the same Japanese Gov’t bond.  This situation has now persisted for months, so I am saying that the U. S. has gone Japanese.  I will also point out something even more contrarian.  This is that except for the late 1970s, in the aftermath of a nearly decade-long guns-and-butter mess in Viet Nam concomitant with the rollout of the Great Society, the U. S. has never had “high” price inflation during peacetime.  With U. S. military activity decelerating in Afghanistan, there may be surprises ahead on the price inflation front.  As in the second half of the 1800s, a productivity revolution is underway that just might have, over time, quite the sustained and beneficial price deflationary effect.  In that setting, the Fed’s money printing would be more anti-deflationary as opposed to positively inflationary (re prices, not money supply) than almost anyone now thinks possible.  I have no accurate crystal ball, but no one does, so who’s to say that optimistic view of things will not be correct?

In a summertime poll of best investment choices for the future, Americans chose gold first and stocks second.  Not many chose bonds.  Probably many of those who did choose bonds were thinking of tax frees (munis), given that they yield more than Treasurys and then have the tax advantage on top of the yield advantage.  This choice of gold as the most favored investment is one reason I turned negative on the price when it hit $1900, as I discussed in August (mentioning that one could assume I sold my “trading” gold).  This was simple trend-following by the public, which ignored gold in 2009 when it was under $1000 and was pretty uninterested in it at $1300 in January of this year.  But $1900 was good a mere 7 months after $1300 had been breached to the downside?  Now there was a momentum play!  (But happily for transient price stability, the price of gold decided to take a rest).

But if one wants a long-term momentum play, one can note that over the past 30 years, starting from record-high bond yields for the post-Civil War era, bonds have outperformed both gold and stocks with less volatility.  What % of the public knows that and is piling into Treasurys for momentum reasons?  Few.  (The pros have been doing so, though, and with leverage:  there is plenty of risk in this market, make no mistake.)  Meanwhile, the DoctoRx “take” on things is that with the 10-year bond now well under its panic 2008 low yield (about 2.08% was the low then), the 30-year has plenty of “room” to approach its low of the same time, of 2.48% or so.  The math, and psychology, of leaving risk assets (think AMZN, NFLX, even copper) to go to the relative safety of bonds is bizarre enough that at least in my opinion, very strange things can happen with these bond yields and it would imply less than one might think.  Thus I contend that a speculative form of crash insurance is a zero coupon U. S. Treasury bond (historically, deficits haven’t mattered in a financial crisis).  Obviously, cash, define it as you will, is far safer on a day-to-day basis and perhaps on a long-term basis.   

The government will, we assume, get its funding.  $41 today will, we assume, become $100 in 30 years.  What that $100 will buy is unknown, but for whatever reasons, the global financial markets are choosing the U. S. markets as a relative safe haven.  Under the financial Theory of Relativity, that’s good enough.   

If in 1980 or 1990, someone had written about these times, that work would have been dismissed as pure fantasy.  But here we are.  They talk of the fog of war.  There is a lot of financial fog these days.  Trying to see ahead through it involves a lot of guesswork and caution.