Montreal, Canada
The bull market in Treasury bonds since 1982 is heading into the bear's digestive system over the next 12-24 months. Some of the shrewdest investors, including Tiger Management founder, Julian Robertson, Jr, have begun to initiate bets against U.S. Treasury bonds in anticipation of higher interest rates (See October 20, 2009 blog on Julian Robertson, Jr.).
Unprecedented global government fiscal spending, quantitative easing, bulging budget deficits – even in Germany – and expensive entitlement and social welfare programs all promise to drive yields much higher in the West eventually. The cost to finance these and other financial time-bombs promises to become more expensive in the age of the super debt cycle and its near collapse in late 2008.
The cost of funding long-term government social welfare programs alone far exceeds the current revenue generated by the IRS. Some sort of entitlements crisis lies ahead.
But a bigger threat looms for U.S. Treasury bond investors – China.
The Chinese are up to their eyeballs in Treasury debt and U.S. dollars with the bulk of their mammoth $2.2 trillion dollars of reserves in American dollar-denominated paper. As Julian Robertson proposed last month it seems almost absurd for the Chinese to continue funding America's trade and budget imbalances if the dollar continues to decline. It also seems stupid for China to accumulate more Treasury bonds in the face of rising supply over the next two years – and the likelihood of higher long-term interest rates to draw international Treasury financing. Higher rates result in lower bond prices.
Yet if the ongoing inverse relationship between stocks and bonds continues into the next stock market sell-off, bonds might surprise everyone with another big rally. That's what the world's biggest bond fund complex is betting on.
Since 1997, Treasury bonds have been one of the few safe-havens amid systemic crisis or a stock market meltdown. After plunging last fall after Lehman Brothers failed, Treasury bond yields hit overbought levels and have ratcheted higher this year to 3.38% this morning compared to 2.25% on December 31 when the financial system was approaching the proverbial cliff.
Bill Gross, probably the smartest fixed-income advisor in the world under PIMCO, recently loaded-up on long-term Treasury debt in September; Gross believes long-term rates will decline under the weight of a double-dip economic recession in 2010 or 2011. The bond bull has made some savvy calls in his lengthy career and even amid a decline in Treasury bond prices this year Gross's PIMCO Total Return Fund is up 14%.
Longer term, I can't find a single reason to own U.S. or European government debt.
Deficits are likely to remain a constant theme for years and in the United States might drown the government as interest costs head through the roof – currently about $200 billion dollars. Mathematics 101 tells you this relationship can't last forever. We also can't expect the Chinese to fund these deficits indefinitely.
Before heavily shorting Treasury bonds, however, consider buying long-term Treasurys. That might be the next great trade for 2010. It's also one of the few assets that remains highly contrarian and unloved by the investment herd.
Bill Gross has rarely been wrong. If you believe, like I do, that the stock market won't continue to advance forever -- up almost 64% since March – then 30-year Treasury bonds are a great speculation right now. Inflation is non-existent, nobody is raising prices and credit intermediation is years away from recovering – especially in the absence of federal assistance.
Time for bonds?
Eric-I can't agree more check out my recent blog on 11-11 discussing the NOB Spread, a leading indicator of market direction in long-dated treasuries
http://chartittradeit.blogspot.com/2009/11/attached-above-click-to-enlarge-is.html
Posted by: Lee M. | November 17, 2009 at 07:18 PM