by Alexander Green, Investment U‘s Chief Investment Strategist
Monday, October 3, 2011: Issue #1613
When the market turns rocky, it’s understandable that some investors run to safety. But these are unusual times. And many of these investors are running straight into a buzz saw.
If you’re one of them, you need to take preventive action immediately. Let me explain why…
While attending my daughter’s choral concert at her school the other night, I overheard two fathers chatting during the break.
“I finally threw in the towel on the stock market,” the first said.
“Me too,” said the other. “I’ve tucked everything away into Treasury bonds instead. I’m not earning much but at least I can sleep at night.”
He’s in for a nightmare instead. Nothing is more devastating to investors than when they plow huge amounts of money into a seemingly safe investment and their world gets turned upside down.
That’s the risk now with Treasury bonds.
Please understand, I’m not suggesting that the United States is a poor credit risk. No one lends money to a deadbeat at 1.9 percent for 10 years or three percent for 30 years. (That’s the current yield on 10- and 30-year Treasuries.) But the good times for Treasuries – which began way back in the hyperinflationary early 80s when the prime rate hit 21.5 percent and long bond yields topped 16 percent – are almost certainly coming to an end.
Welcome to The Treasury Bubble
In the last 12 years, we’ve experienced the technology stock bubble, the real estate bubble and the gold bubble. Now… welcome to the Treasury bubble.
Let’s start with the basics. Bonds work like a seesaw…
- When interest rates come down, bond prices go up.
- When interest rates go up, bond prices go down.
Yields on Treasury bonds have plunged in recent weeks, thanks to fear of recession, chaos in the Eurozone and assorted other unsavory news. That buying has driven 10-year yields sharply lower – from 3.25 percent to less than two percent just in the past few weeks. Investors, of course, aren’t buying these bonds for their potential return. They’re buying them for the perceived safety.
Yet their statement values will plunge in the months (and years) ahead.
Don’t get me wrong. Despite our $14.5-trillion budget deficit, tens of trillions more in unfunded liabilities, this year’s political brinksmanship and the recent Standard & Poor’s downgrade, the creditworthiness of Uncle Sam isn’t an issue. If our government doesn’t have the cash to meet its obligations, it can do something no private borrower can: Crank up the printing presses.
Why Treasury Bonds Are Still a Big Risk
I hope it doesn’t come to that because it would likely be inflationary. Yet aside from any inflation risk down the road, Treasury bonds are still a big risk. And most investors don’t understand why. For example, the other day a friend told me he had recently plunked for the Vanguard Long-Term Treasury Fund (VUSTX).
“Why?” I asked.
“Well, because Treasuries are safe and the fund has returned 8.3 percent annually since its inception 28 years ago.”
Never has the boilerplate “past returns are no guarantee of future results” been more apropos. It isn’t just unlikely that this fund will generate this kind of return over the long haul. It’s mathematically impossible. And the only way it could generate a decent return in the short term is if the United States enters a full-blown deflationary depression, a long shot at best.
U.S. Treasury bonds are priced for calamity. Granted, times aren’t the best right now. We may get a double-dip recession. Perhaps even a nasty one. We may see Greece default on its sovereign debt. (In fact, I hope we do. That would be the first step toward cleaning up the mess in Europe.) But – despite the many Chicken Littles out there – we’re not on the verge of economic Armageddon. That means Treasury bonds will soon start to fall. Hard.
Short-term Treasury notes and bills aren’t terribly risky. (Although they pay almost nothing.) But Treasury bonds (and Treasury bond funds) are an extraordinarily poor bet for the short to medium term.
If you own them – and prefer not to learn the hard way – do yourself a favor and get out of them.