There is Some Place to Hide in This Gloomy Market- Cautiously

In spite of Friday’s 6% US stock market rise, the general mood is gloomy and getting gloomier. This week’s Barron’s was particularly gloomy.

Multiple articles said there is no place to hide. We have said the same, as in our Oct 26 post of the same name, “No Place to Hide”. The fact is, however, there have been places to hide that persist today. They should be considered, but cautiously in these volatile times.

A specific example of the gloom comes from one of our favorite columnists, Alan Abelson, who said;

November 24 (Barron’s)

Was Friday’s late and sharp rebound another of those one-day wonders or is it, at long last, the start of something a bit more enduring … We earnestly hope it is. But … this market has been filled all the way down with deadly head feints. So the best advice we can offer for the nonce is to wait and see — from the safety of the sidelines. … As we keep saying, there’s no place to hide.

He was probably talking about stocks, as we were in our article, but there have been places to hide — not in stocks, but in currencies and US Treasury debt: US Dollar, Japanese Yen, Treasuries, and money market funds.

click images to enlarge

Effective Hiding Places - So Far

Securities listed in the table image are: UUP, FXY, SHV, SHY, IEI, IEF, TLH, TLT, and BSV.

No Hiding Place Is Perfect:

Something can always go wrong.

Money Funds: Generally, money market funds could break-a-buck. It happened once so far this year, but a number of funds would have broken-a-buck if their sponsors had not coughed up significant sums to fix net asset value problems. What if commercial paper became such a problem again, and those same institutions didn’t have the resources they had before to cover the problem?

Treasury Yield Curve

Treasury Money Funds: Treasury money-market funds are not at all likely to break-a-buck, and for that reason we have previously advised our clients to hold their liquidity in Treasury money funds. However, T-Bills are approaching zero yield, and that is a problem for those holding Treasury money market funds.

November 24 (Barron’s)

Moody’s chief economist John Lonski [said] “The problem with zero is it’s going to wreak havoc with money-market funds. I don’t think the Fed wants to do that,” he says. …

His view is seconded in the market. “Treasury money markets won’t be able to operate very long with levels we’re seeing today,” says Jim McDonald, who manages taxable money markets at T. Rowe Price Group. The three-month T-bill to be auctioned this week was quoted at one point Friday at a bid of 11 basis points and an offer of 6 basis points, which isn’t much of a spread to pay fees, he notes.

What will happen when the existing Treasury assets of those money funds mature and the reinvestment options are near zero interest rate? If the gross yield on the Treasuries is less than the management expense ratio of the money fund, what happens? Will Treasury money funds pay a negative return? That would be the equivalent of breaking-the-buck.

Will sponsors waive their entire management fee on a temporary basis to retain assets? Can those managers continue to work for nothing or near nothing as long as the T-Bill market can remain near zero interest rates?

If Treasury money fund managers cannot continue to work for nothing, can they roll the pre-September 19 federally guaranteed asset values into another money fund that holds higher yielding assets (at higher risk) while maintaining the federal value guarantee for investors?

The Treasury money market rates and other money market rates for Vanguard and Schwab are shown below. They are all still positive.

In Schwab’s case, for example, 92+% of the T-Bills in the Treasury money fund will mature in less than 120 days. If rates stay the same, those assets would roll-over to T-Bills that do not cover the Schwab or Vanguard expense.

Vanguard Money Funds

Schwab Money Funds

Treasury Bonds: We have had burst bubbles in tech, real estate, energy, basic materials (such as copper), crops related to energy, China, India, Russia, private equity, and hedge funds. Now the latest bubble may be in US Treasuries. How long will it last? How much further could it go?

November 24 (Barron’s)

Looking for the Last Refuge by Thomas Donlan

The new asset bubble is Treasury bonds and T-bills

… All the world … is still eager to lend to one impecunious borrower: The U.S. Treasury has to beat away would-be lenders at every auction of U.S. debt.

… Treasury bills and Treasury bonds are the new asset bubble. The U.S. Treasury is selling security — return of capital — and the world is as hungry for that product as it was hungry for energy a few months ago.

We have massive Treasury net issuance in front of us, ranging from $1.5 trillion by Treasury Dept estimates, to $2 trillion by other people’s estimates. Those estimates are before possible new stimulus plans to be proposed by the incoming US administration. Adding that much debt to a current base of about $4.7 trillion might bring ultimate interest in Treasuries into question.

China, Japan and the UK are the largest holders of US Treasury debt. The UK is busy solving its own problems. Japan is in recession. China is slowing, but has enormous reserves, and has made statements about its readiness to help the international financial system stabilize.

However, how much more US debt would China and others be willing to buy at current historically low interest rates.

Will the Treasury bubble (high prices and low yields) survive the 2009 debt issuance calendar?

If the US Dollar remains strong, and if deflation persists, maybe low rates will work at the short end, but what about the long end? Deflation for 10 to 30 years may not be a good bet.

US Dollar and Yen: We don’t really know all the reasons why the Dollar and the Yen are strong, but we can observe that they are strong.

One factor may be that the global rush to buy Treasuries increased demand for Dollars. Another factor may be the unwinding of the Yen carry trade (short Yen / long higher yielding currencies) created demand for Yen. There is surely a lot more going on, but the charts tell the story of strength.

Dollar, Yen and Euro

The Dollar, Yen and Euro account for the overwhelming bulk of daily foreign exchange trading.

Investors need to think about what the huge Treasury issuance next year will do to Dollar demand, and what completion of the unwinding of carry trade will do to the Yen. Those issues deserve careful consideration and the exchange situation warrants close observation of Dollar and Yen price movements.

If you are not inclined to play the downside with shorts, short funds and options or futures, then currencies, Treasury bonds and money funds may be your best current hiding place.

Comments

[SeekingTruth:]

Why not lower the rates? With rates lower than inflation, and the dollar strengthening ,it represents "free" money to the Treasury as long as others are willing to buy the ever increasing debt. So far, the ruse is working ---for now, but for how long? Even the paltry rates that they pay are recaptured through taxation. I am afraid the Treasury is living in another Alice in Wonderland dream world, and the wake up call from the rest of the world is going to be most unpleasant for us all, but esp. to bond holders of all types, Treasuries included..

2008 Nov 25 12:13 AM