The Return of Principal

We've always been a bit perplexed by the rush into treasuries in times of acute stress in the capital markets. (The alternative being a move to cash-equivalents).

The typical understanding of the "flight to safety" in treasuries is captured in this observation from a Thursday entry at the WSJ's Marketbeat (emphasis in the original):

"People had priced in a lot of bad news," says Thomas Roth, head of Treasury trading at Dresdner Kleinwort. "No one wanted to buy anything but Treasurys. They weren’t concerned about return on principal, just return of principal."

But here's the thing: Unless investors intend to hold their bills and notes* to maturity, there's no guarantee they'll get that principal returned in the secondary market.

Consider the circumstances of those who bought 10-year notes below the (arbitrarily placed) blue line on the chart below (which depicts 10-year yields over the last six months). At current prices, they aren't getting their principal back. And with such low yields and short holding periods, interest payments are nearly irrelevant to calculations of total return. (Click chart to enlarge.)

The moral of the story is that buying unusually extended asset classes is inherently risky. Always has been. Always will be.

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*The argument doesn't apply to bonds in the same way because it's the short end that gets most of the panic-driven action.

Comments

[cheesecake]

beer is the only investment with a guaranteed return of happiness :)

[deaverb]

Good basic refresher. Most of us err here. Of course, buying 14% 30 year treasuries in the early 1980s may have defied this....

[gordon]

Well... lets see. My best mutual fund, Oakmark Eq & Inc (OAKBX), about as good as available, is +3% ytd. By keeping it in their cash account, I earned the same, without any risk. My Ameritrade safest Treasury mm fund is earning a whopping .75% (30-day average), their in-house (not guaranteed to not "break the buck") is 2% (30-day)
If I picked the wrong stocks (not momentum POT, etc, where fast money is), I lost money unless I scalped for up to 5 pts, and sold(in most cases)
Not a market for most, unless you believe in "long term", meaning be willing to lose a good portion of your retirement.

[gordon]

Forgot: been laddering 3,4,6 month CDs FDIC paying around 3.5-4.5%, feels pretty good at night. Try it.

[DanielJacome]

"*The argument doesn't apply to bonds in the same way because it's the short end that gets most of the panic-driven action."

If people are running into the short end maturities, it implies the St is thinking bond prices will go down as rates will go up -- higher rates on the way? That would entail a better economic scenario an thus a bullish sign according to traditional fixed income theory.