Stay Away from Treasuries - Barron's

While many investment bubbles popped in 2008, U.S. Treasuries could be the next big bubble to burst, Barron's Andrew Bary says. Thanks to fears over the global economy and stoked by the credit crisis, investors piled into Treasuries in 2008, driving yields to levels not seen in half a century. The almost unstoppable rally hasn't left much wiggle room, and prices could fall sharply if yields do rise in 2009. Among the risks: stronger-than-expected economic growth; a weaker U.S. dollar; any sign of inflation; and a rise in gold prices.

The bear market may have begun Wednesday, Bary warns, when prices of 30-year bonds tumbled 3%, and shed another 3% Friday. Some savvy bond managers, including Pimco's (AZ) Mohamed El-Erian, share the sentiment: "Get out of Treasuries," he warns, "they are very, very expensive." The 30-year bond, which now yields 2.82%, could drop 25% if the yield went back up to 4.35% - where it stood as recently as November.

On the other hand, fixed-income investors will find no shortage of opportunities in other corners of the bond market. Bary likes:

• Junk - with an average yield of about 20% (vs. 9% a year ago), investors could do quite well even amid growing default rates. (ETF: iShares iBoxx $ High-Yield Corporate Bond (HYG))
• Munis - AAA munis now yield 5-6% - about double that of Treasuries (and tax free!).
• Long term preferreds - carry an average yield of 8%, 5.5% more than Treasuries, and are taxed at a lower rate (Bary mentions Bank of America (BAC) and Morgan Stanley (MS)).
• Convertible securities - were bashed in 2008, partially due to forced selling by hedge funds faced with redemption requests. Issuers include Citigroup (C), Chesapeake (CHK), Vornado (VNO), Transocean (RIG) and Ford (F).

"The only part of the bond market that you need to be bearish on is Treasuries," Jim Paulsen of Wells Capital says. "The other sectors are attractively priced."

So who's on the other side of the trade? Merrill Lynch economist David Rosenberg, who correctly called the housing bubble, says imploding household net worth and 3% GDP contraction could make the rally linger through 2009 or even into 2010. "Sustained negative wealth effects from the slide in housing and equity prices will reinforce the uptrend in the personal saving rate, creating a highly deflationary environment as job losses mount and push the unemployment rate up toward 8.5% in the coming year," he writes. Bary thinks Rosenberg's outlook is overly grim.

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• Investors looking to short the U.S. Treasury market can use ETFs, including the Ultrashort Lehman 20+Year Treasury ProShares (TBT) and the smaller Ultrashort Lehman 7-10 Year Treasury ProShares (PST) but also simply selling short any of iShares' government bond family, including (from short-end to long-end) SHV, SHY, IEI, IEF, TLH AND TLT.
• Sean Hyman says the time has come to take profits on bonds - and move into gold.
• Larry MacDonald is worried investors looking to short the bond bubble may be jumping the gun. He says watching from the sidelines might be the best bet, for now.
• John Lounsbury takes a telling look at how the yet-to-pop Treasuries bubble shapes up compared to other recent burst bubbles.

Comments

[silverwood:]

Good artilce and I agree with author's opinion to stay away from long side of Treasuries. For an IRA account holders , like me, who cannot short, TBT looks very attractive and appears to have bottomed. TBT have good volume whereas PST 1/5 the volume. This would be an excellent vehicle to trade in and out of as the deflation/inflation outcome unfolds in the coming year.

Jan 04 05:01 PM

[dawase@gmai...:]

I managed to pick up some cheap options on TBT Wednesday AM. Lucky timing more than anything else, but at least I'm starting '09 in the black.

I think the real concern on TBT / PST is that the Fed has said it expects to keep rates low for a long time. I don't know if I really want to take the other side of that trade. Yields are historically low within the context of the US, but if Japan is at all indicative, yields could get even lower in the next year before the system truly starts to bottom.

Another thought, when everyone is calling something "the easiest trade of 2009", you'd best be careful.

Jan 04 06:33 PM

[tinscale:]

silverwood -

Why can't you use one of the ETFs to short treasuries in an IRA?

Jan 04 06:41 PM

[silverwood:]

tinscale, you go long the ETF's in your IRA account, which is simulating a short on Treasuries. You cannot outright short anything in an IRA.


On Jan 04 06:41 PM tinscale wrote:

> silverwood -
>
> Why can't you use one of the ETFs to short treasuries in an IRA?

Jan 04 08:19 PM

[jepittman:]

I would suggest that the Fed is probably not interested in seeing treasuries fall to the point that mortgage rates are negatively affected. They implied in their latest statement that were investigating the possibility of buying longer dated treasury bonds. If that occurs there may not be as dramatic a fall in prices near term as some are anticipating. I do believe however current prices are not sustainable longer term as money supply increases and riskier assets with higher yields and total returns become more attractive.

Jan 04 09:20 PM

[zalo:]

As long as corporate, mortgages, etc rates continue to come down (i.e spreads get compressed), the Fed will allow treasury yields to go up. Other wise going short could be dangerous as the Fed could buy them and keep the rates down and short squeezing the shorts. If this happens what you should short is the dollar, not the treasuries. But, you really want to short the dollar now? What could you buy? Euros, yens, rubles?

Jan 05 12:38 AM

[broscat55:]

I think long treasuries are a trap. Why take 2.6% - A pitiful return plus the risk of a hefty capital loss if rates suddenly rise. And there is plenty of reasons for rates to rise. Big increases in government obligations as baby boomers go on Social Security and Medicare, not to mention all the stimulus and bailout deficit financing and money printing. A wiff of inflation can cause a quick crash of treasury prices. Foreign creditor nations may stop buying treasuries. Unless you have an apocalyptic outlook, you can get better yields with CDs. In practice, their safety is probably as good as treasuries. The government isn't going to let the commercial banking system fail, unless the sky really falls. And there are many other options.

Jan 05 01:08 AM

[driftwood2:]

Everyone knows that treasuries are a bubble but as soon as I learned that the gov may has something to do with this bubble, I sold my treasury shorts. Looking at Japan, rates can stay low for a long time. Also, the timing of this bubble is very odd. It was really created in November even though sep-oct was when most of the worst financial news hit.

Jan 05 01:56 AM

[Timmothy Posey:]

I'm fearful of the vicious cycle that will come if the Treasury bubble does pop. All that money (Nearly $8.5 trillion by some accounts by the WSJ) will rotate back into corporate debt, muni's, and equities. I would expect all of this to happen suddenly as the fear is removed. Any mere hint of inflation or economic growth not being as bad as predicted (and its being predicted to be 1930s-like) and TBT will be the easiest play of the year.

Jan 05 02:49 PM

[Market Folly:]

we agree and would look to short the longer dated treasuries via going long TBT or shorting TLT. you've got to have patience with this one though and it will most likely be a longer-term short. need inflationary pressures to return to really get the ball rolling. no need to rush adding to the position, as we think this has plenty of time to play out. we've advocated the rationale behind this play here: www.marketfolly.com/20...

Jan 05 08:32 PM

[lark:]

It is not clear to me that the FED is going to buy treasuries.

Jan 08 11:48 AM

[Socialism c...:]

Rates near 0 are why Treasuries cannot go much higher. Rates can't go any lower, and "no yield" will not be acceptable much longer.


On Jan 04 06:33 PM dawase wrote:

> I managed to pick up some cheap options on TBT Wednesday AM. Lucky
> timing more than anything else, but at least I'm starting '09 in
> the black.
>
> I think the real concern on TBT / PST is that the Fed has said it
> expects to keep rates low for a long time. I don't know if I really
> want to take the other side of that trade. Yields are historically
> low within the context of the US, but if Japan is at all indicative,
> yields could get even lower in the next year before the system truly
> starts to bottom.
>
> Another thought, when everyone is calling something "the easiest
> trade of 2009", you'd best be careful.

Jan 15 05:06 PM

[boisterousbob:]

Not sure why you are saying treasury yields cannot go negative? I think they can...

Jan 25 09:20 AM