2012 Outlook For U.S. Treasury Bonds

Includes: LBND, TMF, UBT
by: George Liu

2011 was a year of turmoil for worldwide financial markets, with the near unraveling of the eurozone and the euro, continued signs of economic stagnation in the United States, and the wiping out of $6.3 trillion in global stock market capitalization, according to the Financial Times.

Yet, as a result of this economic uncertainty, U.S. Treasury bonds, long regarded as havens for secure investments, have prospered. In fact, Treasury bonds have returned 9.64% this year compared to corporate and high yield bonds, which have returned 7.22% and 4.16% respectively. Compared to stock market returns, Treasury bonds did even better; the Dow was up 5.5% for the year, Nasdaq was down 1.8%, and the S&P finished flat.

The 9.64% return is the Treasury's best performance since 2008, and it should be noted that the 10-year Treasury yield (inverse to Treasury prices) closed below 2% to 1.87% for the first time in history. Not even today's record profit-taking by foreign central banks or the selling of $23B in Treasuries by foreign investors has resulted in higher Treasury bond yields, an example of the magnitude of strong demand these securities are currently facing from other investors.

For at least the first half of 2012, U.S. Treasury bonds pose a sound investment likely to pay off as the European debt crisis shows no signs of abating, emerging markets such as China have shown economic weaknesses, and the U.S. continues to struggle with its downgraded credit rating, political incompetency, and elusive job growth. The Shanghai and Hang Seng indexes were down 22% and 20%, respectively as Chinese companies faced increasing scrutiny and international investors backed away from speculative plays.

Ironically, in the days after S&P downgraded U.S. creditworthiness, investors flocked to U.S. Treasury bonds, and any further downgrades will continue to result in investors seeking the security of U.S. Treasury bonds. The U.S. government still has to deal with finding a permanent supplement to the 2-month payroll tax cut, find a way to counter the effects of the failure of the supercommittee, and adequately deal with another looming debt ceiling crisis. The European sovereign debt crisis, the elephant in the room, although nearly not as bad as the nadir a few months ago, is still a significant problem; just yesterday, Greece reported significant decreases in revenue numbers from taxation that almost certainly will result in a double-digit defict.

As Kevin Giddis, president of Morgan Keegan’s fixed income capital markets, puts it, " the investing landscape doesn’t look all that different.”

Investors should also consider investing in alternatives to U.S. Treasury bonds that are directly correlated to its performance, most notably Treasury ETFs. As fellow Seeking Alpha contributor John Spence notes, Treasury ETFs also led the ETF pack. These alternatives can be extremely appealing to investors who strongly believe in the performance of Treasury bonds and are willing to take on increased risk for increased reward; leveraged ETF fund Direxion Daily 30-Year Treasury Bull 3x (NYSEARCA:TMF) has returned 107.6% YTD while PowerShares DB 3x Long 25+ Year Treasury Bond ETN (NYSEARCA:LBND) has soared 117.8% YTD and ProShares Ultra 20+ Year Treasury ETF (NYSEARCA:UBT) is up 71.3% YTD.

Overall, Treasury bonds and their complementary alternatives are extremely attractive investments, at least for the first half of 2012.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TMF over the next 72 hours.