Ultra Short Treasury ETF: Have Patience, Money Will Eventually Flow Again

What does one make of an investment that is down 40% in 12 weeks, yet has unquenchable investor interest? The ETF in question averaged less than 500,000 shares traded in September 08, but is currently averaging about 2,000,000 in December 08?

Say "Hello" to the ProShares Ultra-Short 20+ Treasury Fund (TBT). This exchange-traded fund seeks twice the inverse of the daily performance of the Lehman Brothers 20+ Year U.S. Treasury index.

Since longer-term treasury bonds have gained more than 20% over the last 3 months of the credit crisis, TBT has been cremated. Even 3 months ago, pundits surmised that the 30-year U.S treasury bond yielding 4.5% was undesirable... yet the bonds rose precipitously as the yields dropped from 4.5% to 4% to 3.5% to 3% to 2.5%.

Yields could drop lower... sure. And that would mean more losses for those investing in ProShares Ultra-Short 20+ Treasury Fund (TBT).

However, I think the frenzied safe haven buying of treasuries has come to an end. And here's why:

1. A-grade corporate debt demand has jumped dramatically. At what is often talked about as the "October 10 lows," investors didn't just leave the stock market; they also left company debt. In fact, they left A-grade Wal-Mart and Procter&Gamble-like debt. At that time, the iShares Investment Grade Bond Fund (LQD) traded at 80. Ten weeks later, LQD is trading 20% higher.

Of course, it isn't just the 20% capital appreciation in corporate debt that's impressive here. It's the fact that it is trading near the 100 price point that it historically traded at before the Lehman bankruptcy and Fannie/Freddie failure. What's more, the 5% annual yield paid monthly is going to keep pushing LQD up to the 110 level, as any yield above 4% will be seen as attractive. And that money will likely come out of treasuries. (Read more on Investment grade bond ETFs right here.)

2. Stock market volatility is declining. I honestly never expected to be declaring a CBOE Volatility Index (VIX) reading of 43 as a "good thing." It's like a summertime in Phoenix, Arizona... "It's 117 degrees and cooling down this week."

In the past, any VIX spike above 30 was a sign of irrational fear. For the last 90 consecutive days, however, the VIX has traded between 30 and 89, breaking record highs and ushering in a new era of heightened "scared-to-death-ness." All that said, the VIX is well below its 50-day moving average. What's more, intra-day price swings have declined substantially each month since October. In other words, treasury overdrive may be wearing a bit thin.

3. Everything and the kitchen sink. The bear market itself may be getting long in the tooth. But stocks still have serious detractors. The possibility of a multi-year recession, as opposed to a "hoped-for" late 2009 recovery, may keep stocks in relative check.

But the central banks/governments around the entire world are fighting the credit crisis with everything and the kitchen sink. Some of the efforts will take hold, encouraging a bit of risk taking activity. That means money will come out of treasuries and go somewhere... whether it's A-grade debt, foreign bonds, emerging bonds, preferred debt, convertible debt. In other words, the money does not have to flow into stocks for the ProShares Ultra-Short 20+ Treasury Fund (TBT) to thrive; it just has to leave U.S. treasuries... and I believe that it will.

Comments

[itmanager8815:]

I have been looking at TBT for some time now but what is preventing me from making a move is the long-term leverage trap and degradation inherent in holding a double inverse ETF (see SRS for example).

Although the less volatile nature of the underlying index (in this case, the long term Treasury bond index) may make this less of an issue.

What are your thoughts regarding value degradation when holding this longer term?

2008 Dec 23 06:58 PM

[Ricard:]

The timing of the flood of TBT-related articles is impeccable. I didn't know how to short treasuries...until today.

This seems like the most no-brainer, guaranteed-to-succeed trade I've seen yet. I've yet to find a contradicting opinion.

Good luck, and happy hunting!

2008 Dec 23 06:59 PM

[Thrice:]

Do you really think treasuries will fall *quickly*? Yes, treasuries have to fall eventually, but Ultrashort investments naturally lose money with time, like options. If you want to make a long-term bet against treasuries, I'd say actual shorting works much better.

2008 Dec 23 07:02 PM

[jepittman:]

The most compelling argument for money to begin coming out of the long treasury is the prospect of a falling dollar vs the euro. Middle east and asian investors in treasuries are being offered a terrific opportunity to cash out. Fear has pushed long dated treasuries to IMO unsustainable levels. With US short rates at virtually zero the dollar should decline vs currencies with more yield. Foreign holders of US treasuries cannot be expected to continue to hold assets with an uncompetitive yield and large downside risk. TBT looks like a good place to be next year.

2008 Dec 23 07:42 PM

[otbricki:]

TBT is a vehicle for short term trading. Pick something else if you plan to short treasuries for a significant length of time or any gains will be consumed by the overheads of creating a double short.

2008 Dec 23 08:34 PM

[CautiousAl:]

Dec 1, 2008 ... One option is for the Fed to buy “longer-term Treasury or agency securities on the open market in substantial quantities,” Bernanke said.
That option is enough to keep me awake at night.

2008 Dec 23 08:35 PM

[Dan Weiss:]

In the short-term Treasuries could actually continue to rally. Economic conditions will remain poor through at least much of next year and the Federal Reserve's new policy is quantitative easing through the purchase of these bonds which would be shorted in these instruments. Keep in mind in Japan that the 10-year rates fell below 1% so anything is possible. Long term, I agree with the author 100% that Treasuries are overvalued but they can be propped up for a long time by the Government.

2008 Dec 23 08:36 PM

[Clifford:]

Shorting Treasuries?!?! You can't find something better to short, really? OK, let me take a stab at this one, here are some better shorts:

SBUX: Cause consumers are not buying $5 lattes in this environment
BBBY: Because they still do not sell basic unscented soap that guys would want and the ladies are cutting back on this stuff
BBY: Because you are only as smart as your dumbest competitor (CC) and because they still do not sell the basics that you can get at Micro Center
CAKE: Sorry, but you are not going out to the Cheesecake factory tonight, Chicken Fried Steak factory perhaps

2008 Dec 23 08:37 PM

[tranquil tr...:]

totally agreed with Weiss that the Fed will print as much money as they want to mop up any T bonds to keep long term rates low, but i do think that 30yr bond yield at 2.8% is a bit silly!! (30 years of 0% inflation and a real yield of 2.8%!!)

Definitely worth shorting once there are signs of economic recovery and risk seeking behaviour comes back.

2008 Dec 23 08:49 PM

[Ricard:]

Glad I came back to this article...sobering discussion.

@Tranquil Trader - I believe by the time you see any signs, it will already be too late. IMHO, the only real question is whether or not you believe the Fed will allow for any significant period of deflation. Seems Bernanke has said he will risk anything to prevent that outcome.

2008 Dec 23 08:57 PM

[Ricard:]

Glad I came back to this article...sobering discussion.

@Tranquil Trader - I believe by the time you see any signs, it will already be too late. IMHO, the only real question is whether or not you believe the Fed will allow for any significant period of deflation. Seems Bernanke has said he will risk anything to prevent that outcome.

2008 Dec 23 08:57 PM

[sheridan:]

Everybody and their dog is getting short treasuries and have had too much time to sell at this current high. Markets never make it this easy- be prepared for a serious shakeout/spike before the market heads south.

2008 Dec 23 10:19 PM

[dawase@gmai...:]

Any significant additional shock to the system will send any addional risk-averse capital into the mid to long end of the T-curve. A big bankruptcy, or another crook uncovered... an unexpected military conflagration... any of these will push the limits even further and will send all of these recent yield seekers right back into the weeds looking for return OF capital instead of return ON capital.

It's an interesting question... who's side of the trade do you want to take? The treasury's side - selling the 30 year at 125+ or the Fed's - buying them at 125+?

Is 2.5% fixed for 30 years to the US govt completely stupid? Yep. That's why I'm not buying the long bond. And by the same token I'm not quite dumb enough to think I can fade the Fed.

2008 Dec 23 11:06 PM

[John Polomny:]

I am pair trading this by going short the long bond and long corporate bonds. One of the reasons for the FED's interest rate manipulation is to drive the excess reserves banks have stashed in treasuries back into circulation. As the author states much of this money will flw into corporate bonds. Not every corporation is at risk of bankruptcy.

2008 Dec 24 02:29 AM

[Anthony Alfidi:]

Just make sure you get some precious metals with your ultra-short Treasury fund. Those ultras are heavily leveraged.

2008 Dec 24 02:37 AM

[bsharvy:]

Why TBT rather than PST? Isn't the "bubble" (I don't think you really get a bubble in a matter of months) in the short-term T-bills?

2008 Dec 24 08:50 PM

[andruomail:]

Long-term bonds are more sensitive to changes in demand than short-term which can more easily be held to maturity in case of bad news (interest rate hikes, credit problems, etc.) At least that's my answer...

On Dec 24 08:50 PM bsharvy wrote:

> Why TBT rather than PST? Isn't the "bubble" (I don't think you really
> get a bubble in a matter of months) in the short-term T-bills?

2008 Dec 29 02:02 AM

[mlyn:]

But one cannot compare the Japanese deflationary period to the U.S. dollar when the latter is the international reserve currency for trading, prices commodities, sophisticated Wall St markets and SEC regulation and so forth.
That's why treasuries are so overbought. It's truly another "Mad-off"-with- the-money scam.

But when the U.S. dollar becomes suspect as a true "safe haven," where will investors go if they begin to suspect all fiat currencies?

As a separate issue, I agree that the quantitative easing might make TBT a problematic shorting strategy for now. The U.S. dollar is going to sink, but no one can predict the timing.


On Dec 23 08:36 PM Dan Weiss wrote:

> In the short-term Treasuries could actually continue to rally. Economic
> conditions will remain poor through at least much of next year and
> the Federal Reserve's new policy is quantitative easing through the
> purchase of these bonds which would be shorted in these instruments.
> Keep in mind in Japan that the 10-year rates fell below 1% so anything
> is possible. Long term, I agree with the author 100% that Treasuries
> are overvalued but they can be propped up for a long time by the
> Government.

2008 Dec 29 03:12 PM

[arkady:]

What is the implication of long term positions with TBT? I don't understand the degradation argument, is it the fee of using the ETF or something else?

Jan 12 01:26 PM

[billy22g:]

Arkady, the impact is of the double leverage. The funds seeks to earn 2x the inverse of the TLT. It updates daily, so a 10% gain followed by a 10% drop does not take you back to where you started. You actually end up 4% pts. below where you started. This compounds over time, so these funds are only good for short holding periods.

Feb 03 01:58 AM

[johngoes:]

I'm with arkady - if I buy TBT at ~$45 today and hold the X shares for two years anticipating that the treasuries will be in trouble and have to hike rates in that time due to dollar devaluation and continued need for gvt to fund SS and medical future obligations, then if my guess is right the TBT will (at 2x inverse blah blah) reach, for example, $95 per ETF share. I sell my goodies and make $50X. How does the leverage affect that equation - or is my understanding of investing in such an ETF fault? (side question from a bond dweeb if I anticipate higher inflation in that period, does that mean the treasuries will also loose value?)

Thanks in advance for the education.

Apr 03 03:16 PM