Is It Time to Short Bonds?

Is it time to short bonds? A growing consensus says yes - as long as the world does not end in the next few days/weeks. Price and yield on bonds work in inverse relationships - as price goes up, yields go down... and prices of bonds have shot through the roof as demand surges. People are scared and hiding in bonds. I heard Rick Santelli say last night the movements he is seeing are not like anything he has ever seen in terms of magnitude, direction and quickness of movement. We can say that about everything in this market.

Many places I read have been postulating this thesis the past month or two - but with the huge drop the past 2 sessions I think now is a better time to strike. The easy way to play is to short iShares 20+ Year Treasury Bond Fund (TLT) - or if, like us, you cannot short individual names to buy the Ultrashort Lehaman 20+ Year Treasury (TBT).

Hedge fund manager Doug Kass just got in this trade the past 48 hours as well via shorting TLT (RealMoney subscribers can read why here)

A once-in-a-generation short opportunity might now be occurring in the fixed-income markets. My experience is that the magnitude of Thursday's price rise is the sort of occurrence that ends an asset class's move.

It is the essence of the anti-implosion trade and a statement that, among other things, oil will not remain under $50 a barrel and that, at some point in the near future, order will return to the world's markets.

I am going to join him - with one caveat. This market is acting poorly and unless we regain S&P 770 in short order I can more downside, which could lead this trade to continue to work against those are in it. So I'm not going to begin a moderate position and then if the stock market recovers, the demand for bonds should ease. But if we have another crash upon a crash this will move against us.

There are also some very good reasons to own this for the very long run if you agree with some of our long term thesis - they span the same reasons that eventually the US dollar will crumble. As the US government layers on more debt, the risk to said government increases. [Nov 12: CNBC Europe: USA May Lose Its AAA Rating] [Apr 15: Could the US Lost its AAA Rating?] [Jul 28: US Budget Deficit to Half a Trillion] To compensate for said risk, creditors will demand higher yields - and prices shall fall. And we shall be creating many many treasuries in the US to pay for all the bailouts we still have to work through (I see at least a half a trillion "New Deal 2.0" stimulus plan coming in early 2009 on top of all the other measures we are doing)

So this has both short term and long term catalysts - however in the very short term as people avoid all risk, they are going to what they deem the safest thing on the planet, which they feel are US Treasuries.

As you can see from the chart, after trading in a range of $56 to $65 (a beautiful range to trade) for months, a level many commentators were saying would be an excellent entry point - this ETF has fallen off a cliff the last 2 sessions, giving us an even more attractive entry point in the $51s. We're starting with a 1.7% stake and will save powder in case that "fall off the cliff" scenario in equity markets plays out next week.

Again, if there is another bone-chilling drop and we see S&P 600s range next week, I could see this ETF falling even further as there is even more panic and "flight to safety" but we are at the point now where people are close to paying the US government (instead of vice versa) for the right to own 3 month Treasuries...

Ultrashort Lehman 7-10 Year Treasury (PST) is another option but the longer dated the bond the more interest rate sensitive it is, hence why we're going with the 20+ year.

Disclosure: Long Ultrashort Lehman 20+ Year Treasury in fund; no personal position (yet)

Comments

[Steve in TN:]

To show the volatility of the TBT (ultra short 20 yr Treas), I bought on Thurs and watched it fall 10% on Fri. I still think I'll make a good profit, but just miss the top one day and see what happens!

2008 Nov 24 09:54 AM

[Mr. Cynical:]

Foolish to short treasuries. Fed has basically said it is going to manipulate long term rates by buying treasuries for their balance sheet.

Everyone knows the fundamentals of US gov't are horrible right now, so this seems like a smart play. Because of this, however, on top of the fed buying treasuries, ultimately the gov't will step in and disallow shorting treasuries to avoid the same fate as Lehman and (almost) Citi (shorted to death).

Good luck with your trade. Hopefully you can sleep at night knowing you are betting against America.

2008 Nov 24 10:33 AM

[helplessobs...:]

Having seen many economic ups and downs I find the action of the bond market puzzling. Normally bond interest rates should be soaring as inflation prospects rise. This puts a strong restraining hand on the Fed. This is strange, but the bond sheriffs will eventually take action.

2008 Nov 24 10:56 AM

[mlyn:]

I'm new to investing so I don't quite see the big picture and all the related elements in the picture. But my questions are: If one buys precious metals, isn't that the same as shorting the Treasuries? If the Fed buys the T-bonds, won't that prevent the U.S. dollar from falling? Can't the Fed and other central banks continue to suppress the gold price?

2008 Nov 24 02:19 PM

[buyitcheap:]

I agree - from a risk reward basis, this is a very solid trade.

2008 Nov 24 03:42 PM

[soonerxii:]

shorting America...lol. That's funny comrade

2008 Nov 24 05:40 PM

[mahoney:]

I like TBT too. The way I see it, we are either going to see deflation or major inflation over the next few years. It seems to me that TBT wins in either case. Deflation compounds US government debt, which diminishes the credit-worthiness of T-Bills. Inflation, on the other hand, makes the puny yield on T-Bills unattractive. Either way the 30-year bond looks overpriced. I am by no means confident about this analysis, however, and I would appreciate any commentary, especially with regards to the deflationary scenario.

2008 Nov 24 08:46 PM

[letsmakemoney:]

Everyone is talking about this trade lately (long TBT). The long term reasoning is sound, in terms of the 30yr Treasury yields needing to rise eventually to compensate for the US gov printing presses working 24/7. However, the short term (flight to quality) trend may persist longer than anyone knows. Another way to play the inflation trend is via diversified commodity vehicles such RJI or DBC. The dollar does not need to weaken for commodities to rise, but it would certainly be a tailwind.

2008 Nov 24 09:30 PM

[random2348:]

www.bloomberg.com/apps...
----------------------...
Summers said ballooning debt isn't a major issue for now because there's ``excess demand'' for Treasuries rather than excess supply, as investors flock to government debt as a haven.
----------------------...

2008 Nov 25 02:32 AM

[je:]

I think you could be a couple of days early. My technicals show the probibility ofsome near term selling which if it happens could bode well for the bonds. Late Wed or Friday might look better. This also appears to be a short term trade -two to three weeks before meeting the break out line.
This will not let me post a chart.

2008 Nov 25 11:12 AM

[random2348:]

Obama's Yuan Calls May Cause Collision With China

www.bloomberg.com/apps...

"Obama said China must stop manipulating the currency in a letter to the National Council of Textile Organizations released on Oct. 24. The People's Bank of China has kept the yuan almost unchanged against the dollar since mid-July as it shifts focus from countering inflation to sustaining growth amid a global credit crisis. The Foreign Ministry said last week the U.S. shouldn't blame its trade deficit on exchange rates."

There could be a trade war with China. American manufacturing has been demolished by China and the yuan peg will be an attractive target for Obama. How can American manufacturers compete with a foreign competitor who keeps its currency artificially weak? (Some people may dispute that the yuan is being kept artificially weak. Well, why not let it float and let's see where it ends up?) I don't expect China to dump Treasuries even if there is a trade war, but I think it might curtail its purchases somewhat.

2008 Nov 25 03:38 PM

[Illusion Maker:]

Don't confuse the Government with America.


On Nov 24 10:33 AM Mr. Cynical wrote:

> Foolish to short treasuries. Fed has basically said it is going to
> manipulate long term rates by buying treasuries for their balance
> sheet.
>
> Everyone knows the fundamentals of US gov't are horrible right now,
> so this seems like a smart play. Because of this, however, on top
> of the fed buying treasuries, ultimately the gov't will step in and
> disallow shorting treasuries to avoid the same fate as Lehman and
> (almost) Citi (shorted to death).
>
> Good luck with your trade. Hopefully you can sleep at night knowing
> you are betting against America.

2008 Dec 26 03:10 PM