U.S. Treasuries: Time Tested Insurance Against A Stock Market Crisis

by: Eric Parnell, CFA

It seems that virtually all asset classes decline sharply during periods of market crisis. But one asset class has stood the test of time over the last several decades. U.S. Treasuries have provided an ideal safe haven for investors during times of crisis. And for those investors seeking to hedge their portfolios against a sudden sharp drop in stock prices, the Treasury market would likely provide an attractive way to continue to hedge in the current environment.

A review of recent market history over the past three decades highlights the benefit of owning U.S. Treasuries (IEF, TLT) during times of crisis. Once the back of high inflation was broken and a prolonged period of price stability got underway in the early 1980s, we have had seven separate sharp stock market corrections of -15% or more in the thirty years since. The following is the performance of the stock market along with the returns of the 10-Year (or IEF) and 30-Year (or TLT) U.S. Treasuries over those same time periods.

August 1987 – December 1987

Stock Market (S&P 500, Peak to Trough Total Return): -33.51%

10-Year U.S. Treasury (Total Return Over Corresponding Time Period): +8.14%

30-Year U.S. Treasury (Total Return Over Corresponding Time Period): +11.54%

July 1990 – October 1990

Stock Market: -19.92%

10-Year U.S. Treasury: -1.55%

30-Year U.S. Treasury: -4.30%

July 1998 – October 1998

Stock Market: -16.70%

10-Year U.S. Treasury: +8.37%

30-Year U.S. Treasury: +9.84%

March 2000 – October 2002

Stock Market: -49.15%

10-Year U.S. Treasury: +20.83%

30-Year U.S. Treasury: +20.05%

October 2007 – March 2009

Stock Market: -56.78%

Intermediate U.S. Treasuries (NYSEARCA:IEF): +19.29%

Long-Term U.S. Treasuries (NYSEARCA:TLT): +21.90%

April 2010 – July 2010

Stock Market: -15.60%

Intermediate U.S. Treasuries (IEF): +7.08%

Long-Term U.S. Treasuries (TLT): +13.87%

April 2011 – October 2011

Stock Market: -19.39%

Intermediate U.S. Treasuries (IEF): +13.63%

Long-Term U.S. Treasuries (TLT): +34.55%

In each of the above instances, U.S. Treasuries significantly outperformed the stock market. And U.S. Treasuries often posted strong double-digit returns at a time when stocks were plunging in a sharp double-digit decline. Thus, an allocation to U.S. Treasuries has proven highly beneficial during periods of crisis in the stock market.

The only instance when U.S. Treasuries actually posted a negative return simultaneously with a sharp stock market decline was in 1990, which was a pullback characterized by uncertainty and a sudden spike in inflation resulting from the outbreak of the first Gulf War. While the decline was relatively modest during this time period, it raises an important point that should be incorporated into portfolio thinking when looking forward.

U.S. Treasuries would likely continue to post strong performance during new periods of stock market stress in the coming months. This is due to the fact that such stress would likely be associated with the ongoing threat of a deflationary financial crisis and recession. With this being said, inflation pressures are no longer benign. While aggressive monetary stimulus has not resulted in any sustained wage inflation, it has brought rise to asset price inflation along the way. The presumption has been that if the economy were to roll over that any recent asset price inflation would quickly abate. However, if asset prices continued to rise at the same time that the economy is decelerating – a dreaded stagflation scenario – this would be decidedly negative for both stocks and U.S. Treasuries. Therefore, inflation readings should be watched closely when maintaining a stock portfolio hedging strategy using U.S. Treasuries.

Taking this inflation point one step further, it should be noted that we are now in the final innings of what has been a U.S. Treasury bull market for the last three decades. At some point this bull market will end, particularly given the fact that the seeds of long-term inflation that have been sown by aggressive global monetary stimulus. As a result, any U.S. Treasury positions should be viewed with a short-term to medium-term perspective.

So what is an investor to do if such inflation flames were to eventually ignite. This is where the allocation to precious metals such as Gold (NYSEARCA:GLD) is important in an overall asset allocation strategy. Not only does Gold provide protection during periods of crisis, it also provides a very attractive hedge against periods of rising inflation.

Bottom Line

U.S. Treasuries has provided time tested portfolio protection against periods of stock market crisis. And this benefit is likely to continue as long as inflation pressures remain in check.

Disclosure: I am long GLD.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Additional disclosure: I had been long TLT until recently and may consider reinitiating long positions on pullbacks to its 50-day moving average.