Lets dig deeper in the hatred for Treasuries.
"If you hold U.S. Treasury bonds now, you have to sell. The yield does not adequately compensate you for the risk."
I bet you have heard something similar to this. Looking at my list of Treasury bears who are widely followed, it now includes the likes of Jim Grant, Richard Russell, Porter Stansberry and a club of his writers, Marc Faber, Jim Rogers, and the list goes on and on.
Everyone is so sure that rates are going up this year, yet bonds are near the best performing asset class yet again.
Everyone thinks the collapse is imminent, and will send America to its death.
C'mon folks, let's look at real life examples instead of conjecture. Claiming the end of America with the collapse of the bond market is fear mongering and probably sells lots of subscriptions as well as gets one a lot of air time. But we have recent history to show this not to be the case.
Let's tackle this issue. First, all one needs to do is to look at Japan. Their debt to GDP ratio makes the USA blush when it sees it.
Take a look. Japan carries over two times more debt compared to GDP than we do. Are their bonds spiraling out of control and plunging? I mean, that plus all the QE that they did from March 2001 through March 2006 should have destroyed their bonds and sent interest rates through the roof, right?
Well, not exactly. See below: (Click to enlarge)
Hmm... if high GDP (twice as high as the US) and printing money to buy bonds didn't sink the long bond in Japan, what will?
Some will argue that Japan could do it because they funded their deficit with internal savings. To which I say, that was more than offset by the fact that they had this 20-year downdraft during a massive world wide, debt induced expansion. That massive expansion actually helped give Japan a little bit of inflation. The US will not be so lucky. Deflation is digging its dirty claws into the economy.
Everyone is certain that the Fed will not allow deflation to take hold, because they have the printing press. Is that a fact? Then why is Japan still struggling with deflation even though they flood the world with yen? It's not a new phenomena either. It's been a two decade long struggle. Why are we going to be so lucky to avoid it?
My advesaries will debate it is because Ben Bernanke is bent on destroying the dollar for the sake of growth. Again I ask: 'is that possible.' First of all, if it could happen, it won't happen overnight as we are the world's reserve currency. It will take years.
Secondly, it's a bit impossible based on the way the USD is priced. If the USD is priced against a basket of other currencies and its price is relative to those currencies, a dollar crash would mean other fiat currencies would explode higher. I am of the camp that fiat currency is on the way out and one must own Gold, but as we have seen this year both Gold and the USD can go up together against all the other paper money in the world. I expect this trend to continue. If the dollar crashed, the yen and the euro would explode higher. Think about that for a minute. Are Japan and Europe that much safer than the US? I would argue that their problems are much bigger at the moment than ours, although we are quickly trying to catch up, and yet our debt offers an even more attractive yield than theirs.
Another argument that is getting as old, as it is wrong, is that treasuries do not offer an attractive return in relation to the risk. As I have argued before, the saying goes, "who in the their right mind would lend the bankrupt US money for 10-30 years at 3-4% interest rate? That is not enough of a return for the risk.
Time to face reality folks -- 3-4% per year would have put most stock fund managers into the stock pickers hall of fame this past decade. Too many people are holding on to the idea that we are still in a 7%-10% stock return world. In the "old days" that argument might hold some weight. Who wants 3% when you can get 10%? The truth is, though, stocks have returned less than 0% for over a decade. In relation to a negative return, that 3-4% is looking pretty high now isn't it? Japan bonds offer about 1.5% rates. Not very high if your brain is entrenched to expect 7-10% returns on your investments. When placed in light of a 75% drop in equities in Japan over a 20+ year period, those 1.5% annual returns are actually VERY high.
So on a historical basis, yes, bonds yield little. On a relative basis, the yield is still very high compared to stock returns. In a debt deflating world, taking risks hoping for big asset price gains is a fools game in my opinion. If you can find some big blue chips that yield more, grab those, otherwise, let the debt destruction run its course.
Bond bears will also claim that debt is piling up at astounding rates here in America. I would counter and ask, 'whose debt?' If you just look at the governments side of the ledger, then yes, I would agree with you. But if you take private sector debt into the equation, then I would argue that the Fed is not printing enough money to offset the total debt being destroyed in America. All one needs to do is look at the most recent Fed Funds Z1 report here.
Take a look at page 17 of the PDF (which is page 10 of the report itself). Line 1 shows total net borrowing. As you can see, there is a negative sign before the number. That is debt contracting. It has been like that for many quarters now. Now look at line 8. This is the federal governments debt load. As you can see it is exploding. So in the face of massive printing, QE, federal debt exploding, total debt outstanding is still contracting. As I said - the FED did not print enough money or take on enough debt to offset the de-leveraging going on every where else.
All that debt will eventually turn into inflation, I agree. But until the velocity of money picks up, inflation is a moot point.
Velocity will not pick up until banks lend and borrowers borrow and spend. The Fed could hand every American $1 million printed dollars, but if those Americans don't spend them business owners will keep dropping prices until they find the sweet spot in which those who hold the cash are willing to depart with it. Printing alone will not cause massive inflation. The spending of printed dollars will. At the moment, a new frugalness is gaining strength with American consumers based on a 6+% savings rate at the moment. People have more stuff than they need, and are not able to afford more. Fix the employment problem first, then worry about inflation. With end demand for products sinking, businesses do not yet have an urge to hire. We are a long way from that.
If you want to argue that people are currently flooding into bonds based on money flows into bond funds, and is therefore in a bubble, you have to understand that they have a long way to go. Treasuries as a % of household net worth is near historic lows, and this in the face of lower stock and real estate prices.
Baby boomers are retiring en masse now. They have been hurt badly by two massive bear markets. They can't afford to sit through another one while the job market is weak. Income is what they pay their bills with since capital gains are no guarantee. They have a lot of buying to do before a bond bubble is in place. My guess is that we are seeing the beginning of what Japan saw, the internal funding of the US debt load by American savers.
When you start to hear your neighbors brag about the 10-year they just bought at auction at the cocktail party, then you will know the bubble is here. In the meantime, I'll stick with the hardest trade in the world, being in love with fixed income.
Disclosure: Long TLT, BND
