The Name is Bond…Treasury Bond

The 10-year Treasury bond hovered around 4% recently, and the 30-year bond is trading within a couple-dozen basis points of 5%. What inflation?

A year ago, people were flocking to the safety of negative returns on short term paper to get out of the stock market. Worse, many locked themselves into 10 and 30-year bonds paying just over 3%. Reminds me of the 80s when long bonds were paying over 15%…nobody wanted them then. Now, they can’t get enough. Investors are always doing the wrong thing at the wrong time.

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Keep an eye on that 30-year yield. It’s approaching very precarious territory. Considering the negative returns from the stock market over the past decade, there will be a storm of interest in the long bond if it cracks the 5% mark. The stock market will be the loser if that happens. But, will it happen? And why?

Well, I think it will happen. In fact I am shocked that it hasn’t already broken five percent or even 6%. Considering the amount of paper the US has in circulation, The Fed must be doing cartwheels only paying 3% or 4% to the Chinese when they take our worthless paper off our hands and send us hard goods in return. There are two reasons why 5% will happen and maybe even more…much more. First, as I have already mentioned, inflating the currency is a sure way to pressure rates higher. And issuing so much government paper means more supply. When you have more supply than demand, at some point you are going to have to pay more yield to get the paper off your hands – Economics 101.

Second, when you print so much money, increase entitlement spending to the point that deficits are staggering as far as the eye can see, and when your Sovereign Debt Rating is under fire, investors will ask for more rent for their money. Right now, the US is facing the prospect of much higher rates even though economic growth ex-government is barely showing a pulse.

So, how can you benefit from this in the shorter term? There is an inverse ETF that moves higher when Treasury prices move lower. The symbol is TBT on the NYSE. Here’s the Yahoo blurb on it

(ProShares UltraShort 20+ Year Treasury (the Fund), formerly ProShares UltraShort Lehman 20+ Year Treasury, seeks daily investment results that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index (the Index). The Index includes all publicly issued, the United States Treasury securities that have a remaining maturity greater than 20 years, are non-convertible, are denominated in United States dollars, are rated investment grade (at least Baa3 by Moody’s Investors Service or BBB- by Standard & Poor’s (S&P)), are fixed rate, and have more than $250 million par outstanding. The Index is weighted by the relative market value of all securities meeting the Index criteria. The Fund takes positions in securities and/or financial instruments that, in combination, should have similar daily return characteristics as -200% of the daily return of the Index. The Fund’s investment advisor is ProShare Advisors LLC.)

Remember to read the fine print! This index resets on a daily basis, so it’s really for short-term traders to jump into when the trend looks like it’s your friend. It’s NOT a long-term play, which would be too good to be true.

Between a Rock and Hard Place

With yields moving higher, the odds are increasing that the market is nearing its top for the short term. Consider that the recovery is fragile. If not for the hundreds of billions in lost equity sitting off the balance sheets of the big banks, we would be in a Greater Depression right now. Well, there is no better way to cut the legs out from any recovery than higher interest rates. But wait, isn’t it the Fed that determines interest rates? I mean I can’t even count how many times Bernanke has said that rates will stay low indefinitely. What gives? Why are they moving higher?

Dear reader, the Fed can only influence short-term rates, the market determines what it will seek in the long term. That market is now saying that it wants more risk premium, not so much because it sees growth, but because it sees underlying fundamental stresses that could once again derail the financial system. The Fed is impotent against long-term market forces and unless the US gets its house in order pronto, you can look forward to paying more for your borrowings.

For financially stressed consumers this is bad news. His job is in jeopardy, his house is worth less, his energy costs are increasing, his taxes are going higher and now the cost of borrowing is in the midst of moving up as well.

What better news could there be for companies and the market? There is a saying on Wall Street that markets like to climb walls of worry. Well, there is a lot to worry about today and the market is climbing for sure. Dow 11,000 is in sight; bullish sentiment amongst investment advisors is swamping bearish sentiment. Confirming indicators for the Dow Theory are in place (the Dow Transports are setting 52-week highs), the Nasdaq is also setting daily highs. It just couldn’t get any better than this! Ignorance is such sweet bliss.

This is not some type of inexplicable conundrum. No, the explanation is quite simple. The world is awash in cheap money again and it’s finding its way into the markets again. The Fed and ECB have pumped so much liquidity into the system that the short term looks very rosy for the markets. Problem is that we’ve read this story before. When markets move up on liquidity and not fundamentals, the results are never pretty. But, as Keynes once said “markets can stay irrational longer than you can stay liquid”. Something to ponder.

Best regards,

Kevin Raymond

     
     
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