A reader asked if I thought the treasury market was in a bubble. He was probably prompted by this news about bill rates going to zero.The word bubble is a tad overused doesn't really bring much to the table in terms of figuring things out. If you think it is a bubble fine, if not that's fine too.
Clearly the action in the bond market is bizarre and might be telegraphing a problem coming, a big problem. I am probably not the one to tell you ahead of time what the dominoes will be so much as point out a couple of watchout situations.
Clearly there has been a buying panic in treasuries of all maturities. The ten year is under 3%, the 30 year is close to 3% and the shortest bills are at zero with some wondering if yields will go negative. Municipal paper is yielding a lot more than treasuries with like maturities. Corporate paper is doing odd things as well--spread wise.
This all strikes me a a warning. The muni over treasury yield is not a blip for a day or two but has been going on long enough to reasonably be called persistent. Some have said the bond market might be worse off than the equity market and I think that is pretty close to right.
Treasury rates are essentially at all time lows. At some point when something (the yield) can't lower then it will go higher. Yield up means price down. The money being printed for all these bailouts creates a path for price inflation (larger money supply is the definition of inflation) once the asset deflation ends if not sooner. This threat could cause anyone buying our debt to demand higher yields for the various risks they are assuming. This is also an argument for a weaker dollar.
There is nothing that says this has to be the outcome, although it is what I believe, and obviously it is ok to look at this and draw a different conclusion but if you manage your own portfolio you should know some of the particulars and have an opinion.
If you use fixed income as a means of evening out the equity portion of your portfolio then I would say this is not a great time to be overly aggressive.
35 comments:
I too am very worried. Muni bond yields are at all time highs (higher yield, lower price) and state governments have budget issues. I know, we haven't had a default since the cows came home but it feels like one is coming. And speaking of dominoes! Do I hear the word bailout? Then the fed would own the state and we wouldn't need governors. If you live in IL that's a good thing.
So, back to your story. What defensive moves are you considering in case this shoe drops? Go to cash and get 1 1/2% in a money market? Buy the TBT? Buy a put on the market? Go to a mutual fund that plays both ends?
Inquiring minds would like to know.
Hey Roger. I think this is a huge question. Thanks for bringing it up. I'm the patsy at the table: I ignored the sirens on the equity side until much too late and now I'm sitting here slack-jawed, not knowing what to make of the bond message.
Longer term, whenever that is, I think you're right about inflation, higher interest rates, and a weaker dollar. If that's the case, though, why is there a buying panic in treasuries? Why would anyone tie up their money for essentialy no or even a negative return with that scenerio staring them in the face? It strikes me that the only answer from an investing standpoint is purely safety, even moreso than money markets or other cash options.
But is there a bigger message here? Is the smart money telegraphing huge deflation first and maybe even the other D word? I know most folks don't think so, that we're not even close to that situation, that we're not Japan, and all the concerted global efforts will make it different this time.
So why is there a buying panic in treasuries? Obviously, I don't get it.
Roger - I agree that the bond markets telegraph news clearer if not louder than the equity market. This is not shocking since most bonds you know the purchase price, maturity price, time, and yield. What I am wrestling with are the basics - are the yields out of wack simply because if irrational fear? There are terrific issues out there - in corps. and muni's on an individual basis that may not be appopriate for most do it yourself'ers. As a follow up, I would jsut add that if your PM is putting you back into bond funds or adding to them, they better be able to explain the volotility. FYI - PIMCO's CIO Mohammed El-Erian has pretty much said the opposite...although he may have an agenda with that.... Thanks for the blog.
To tie it into the recent discussion of the Harry Browne/permanent portfolio......
It's not a great time to buy Treasuries, eh? At least gold is down a bit.
How come I keep reading that TIPs are a good buy now because they are at bargain prices?
"The word bubble is a tad overused..." - Yes
"Clearly the action in the bond market is bizarre and might be telegraphing a problem coming, a big problem." - Yes
"This all strikes me a a warning." - Yes
You recognize the issues well. Your prognostications on inflation/deflation are significantly lacking IMO. Not that it is easy for anyone to understand or predict.
Recognizing the problems at hand should be extremely helpful in avoiding catastrophe with ones portfolio so you are way a head of the game IMO.
Everyone has been predicting massive inflation. Oil was $100 a barrel higher than today. Fed/government actions and effectiveness are VERY difficult to predict.
I recommend everyone remembers what happened to oil and other commodities. Just because this eventually ends in inflation 12 months or possibly 12 years from now does not mean we will see inflation any time soon.
11% guy, for now i'm not doing too much with fixed income. The issue with TBT is that it will go up if yields ever go back up but it does not do anything for the rest of a fixed income portfolio. nothing wrong with being overweight cash. i am a big believer in keeping things simple expecially where fixed income is concerned. until things get normal I feel no rush.
the fear that exists of course will exceed the final reality so for me how much of the fear-ride to i want to take? i prefer less.
anon 7:01 trying to figure this out with logic and reason probably won't work. people are afraid of money markets these days. that sentiment along with the unwinding of everything are probably part of the equation but I can't really speak to the fear that exists.
if it is true that the market is worried about deflation then it makes sense that some would view inflation protection as cheap.
anon 7:34 obviously i am more focused on spotting where trouble might be than winning the prize for getting every nuance correct. i simply am not smart enough to be the nuance guy.
One explanation that I heard is hedge funds are buying treasuries (as they sell other positions) so they'll have cash for upcoming investor redemptions.
initial run up in T-bills and t-bonds happened because people realized we are in less worse shape than the rest of the world.
The recent run up is due to the fact that the banks were given 100s of billions of dollars that they are not lending out. they are buying 1-3 month t-bills with the TARP money.
They do not care about the yield, it is free money after all.
The Fed/Treasure are also issuing paper and buying it themselves (absurd i know) in order to push mortgage rates down to the 4-5% level and "revive the housing market".
What scares me is the "experts" who claim the bailouts and Fed money pumping won't cause massive inflation and devaluing of the dollar point to Japan as the guide.
Granted, Japan hasn't experienced massive inflation due to their National Bank dropping rates to 0%, but their stock market is still well below the high set in 1989. I don't know if that is any better than the alternative.
nuance?????
If you think the magnitude and direction of inflation/deflation is a nuance we all do not have to get right you could loose a lot of your wealth.
the nuance i refer to is knowing the exact path we take to where ever we are going, knowing the exact sequence of what smaller picture things come next--nuances.
Born2Code--Those seem like reasonable explanations, thanks. Personally, I'm blaming the Icelanders.
"cause massive inflation and devaluing of the dollar"
Bernanke's theory (and I stress theory) is that they are not raising the money supply. The money is being used to shore up the capital position of the banks so that they remain solvent.
Anyone know what the problem is with staples? Stocks like KMB,PG,JNJ,et al look like they have the flu!
Congress has chosen members of an oversight committee specifically for the Troubled Asset Relief Program. The oversight committee members which lacks the ability to have proper oversight Which is defined as an oversight committee they should be looking for an omission or error due to carelessness, unintentional failure to notice or consider; lack of proper attention and supervision; watchful care. Supervision is a process that allows it to oversee a process during execution or performance; superintend needs to be replaced without regard to political affiliation.
http://nomedals.blogspot.com
As a retiree, I've a portfolio similar to "the 11% Guy" & heretofore have looked on the bond market as has "Born2Code". Today, I'm considering that market is forecasting the 2nd-round effects: faster econ.downturn due to car makers imploding. Today's news about newspapers & local news stations seeking to restructure debt, to try to survive a loss of 40% of advertisement. Perhaps weakness is begetting more structural weakness in the real economyu -- that negative feedback loop that Roubini refers to. (Compared to the equity market where dumb money, including a bit of mine, is getting walked up.)
Anna
Nouriel Roubini has added TIPS to his buy list. Since he saved me from losing my shirt I will now be investing in TIPS via the etf TIP. He has yet to let me down.
Here are my impressions on what is going on. I expect to change my mind as I learn more.
I think the short term yields are so low because of three basic reasons: the banks agreeing to put the bailout money back into Federal debt, end of year window dressing / redemptions prep, and general risk averseness from all quarters.
The longer yields are going down because people fear that returns on everything are going to drop very low for a long time. We are seeing defacto deflation right now. Consider this; are you paying more for anything than a year ago?
I see three basic outcomes possible from the Federal governments efforts, and I agree with Roger that it is just nuance that will decide between which future we will see. You would have to predict which butterfly is going to flap at the wrong time.
I think the Fed wants to expand the money supply to bail our financial system out while avoiding deflation or secondarily inflation in the general economy. One outcome is that the Fed won't be able to juice the money supply fast enough and deflation will reign as businesses slash prices and oil / commodities keep falling from a spiral of slackening demand. Own long US bonds in this case.
Second option is that the Fed will plan it perfectly: bailing out the banks and then shrinking the money supply just as the economy starts to turn over again. Cash and stocks would be fine to hold if you want to bet on this scenario.
Third scenario is that the Fed will either over shoot with money supply, or banks will figure out a way to leak their free liquidity into the general market, or the world demands higher yields from our debt. In this case brisk inflation is the only option, and you should own gold and commodities. Gold will get a double boost here because it is a hard asset, and second because it is the world's alternative to the dollar as a reserve currency. For this reason there may be sharp elbowed efforts to determine who can control the most gold - that is what the tinfoil gold bugs are always worried about.
people are always saying we are not like japan. with what is coming in our world, we will wish we were japan. who's auto industry is in need of a bailout? they were a wealthy country w plenty of savings when they took there interest rates to zero. we are a debtor nation (1.33 times the debt to equity) with virtually no wealth left. the money print that is coming is going to cause massive inflation on goods that are exportable, magnified by a falling dollar. the only thing that will be deflating are the assets we have that are not exportable, i.e. our real estate.
we must let these bad businesses fail, so that resources can be reallocated efficently. what we are doing now is just going to make it all worse down the road.
Roger,
Given that small tweaks at turning points give some confidence, if you were me, a retiree heavy into Treasuries, some TBT as a hedge, some TIPS as a hedge, some discounted investment-grade bonds as a hedge, dividend ETF's (domestic & foreign) & alot of cash, etc., would you have to next look at the oversold asset classes such as commodities, gold? I tend to use 3-4% each, but I don't feel very diversified. Thanks in advance for your opinion. (My biggest problem/challenge seems to be how much to put nto "hedging". Too cute, I know, but I feel like an old hedgehog.)
Anna
I found out why staples are down...Rotation.
I didn't get the memo!
Barry has a post up on this same subject today. He suggests the zero yield environment is being driven by fears of a deepening global recession next year and that it could have negative implications for all types of investments, not just fixed income.
Dr Sohn tells us this is the first of three stages:
www.drsohn.com/d/Commentary/viewPost.aspx?PN=72
Very interesting synopsis of El-Erian at advisorperspectives.com. He sees inflation becoming an issue in mid-2009. He, too, recommends tips, sees value in commodities, and suggests that investors avoid equity risk, especially in financials. It's worth reading.
Investing in bonds at this time is the same as playing russian roulette. the shoe will drop. negative return for a 4week t-bill.
I was thinking about the statement that the bond market is worse than the equity market. This is hyperbole right? If the bond market is going to see lots of defaults then that means that the equity holders would be totally wiped out already? I guess some entities like cities don't sell equity...
Stephen regarding when to buy long treasuries; someone who was going to put money toward Browne's permanent portfolio would expect that one or two of the components would be doing well at any one time. There should rarely be a time when none of the 4 are out performing. I am not making a forecast but TLT is still yielding 3.8% so there is conceivably room for further price increases.
Anna Hedgehog ;) I don't follow how TIPs are a hedge for your portfolio; it seems like they will just basically break even during inflation so they can't really make up for the losses in the rest of the portfolio right? Also what do the corporate bonds hedge against? It seems like they would do well if the credit and economict crises abate, but I imagine the rest of your portfolio would do fine in that situation - unless you have really bearish holdings I guess.
careful with that still yielding 3.8% line of thought. Every bond ETF I've looked has a different payout every time. If 3.8% is a trailing number then it tells you nothing about what the yield will be.
That's true about bond ETFs Roger. In the particular case of TLT, it buys non-callable non-adjustable bonds only issued by the US government. The most recent 30 year bond auction was last month with a median yield of 4.2%. The next auction is probably going to be in Feb 09, that auction will move the payout up or down to the extent that the offering size is large enough to change the aggregate yield of the 20+ US bond market. Hopefully I am thinking about this correctly.
i don't think you are. there is paper coming and going from the fund every day, yields change every day, an auction from august means very little (IMO).
I think there is great value in some corporate bonds but I hate bond funds. I'd rather have control over maturity and there for select individual bonds. I don'tr know how you do fixed income but perhaps you can pass on some information on how or where to analyze a bond for safety of income and ability of bond issuer to pay it back.I have usually depended on bond ratings but not very comfortable with rating agencies now.
Ron
Roger, enjoy your blog. I just looked up how the Vanguard Intermediate and Long Term Treasury funds have done this year. The intermediate term fund is up 11% and the long term is up 17%. Treasuries looks like the only thing up this year. Can you or anyone tell me why it's a bad idea to put money into either of these funds? The Senate Republicans have killed the auto bridge loan, so unless Bush releases TARP funds to the big three car companies, we're in deep shit. I think deflation is what we're going to be contending with. Intermediate and long term treasuries is what works in a deflationary scenario. Or, am I missing something significant?
Helena, the only thing to add is that yields at all time lows means prices are at all time highs. the price may not go down but these prices are all time highs.
Long term yields did fall into the 2s between about 1935 and 1955. If you think the price move has been powerful with the 40bp yield drop we have witnessed, just think what would happen if the yield dropped that far!
I think it would be a bad idea to speculate against deflation, by not preparing your portfolio for that scenario. But you also don't want to hose yourself if we stumble back toward inflation though. I have been posting about the "permanent portfolio", the past few days as I try to grapple with preparing for the possible scenarios...
Thanks for your responses, Roger and Matthew.
I looked at Permanent Portfolio but decided I could do the same thing on my own. Maybe that is hubris. But, last year it looked to me we were going to have a deep recession, so in January I pulled 70% out of the stock market and went into money market and treasuries.
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