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Shorting U.S. Treasuries, a Historic Sucker Bet
MKC Global Investments, LLC
If forced
into a career other than one in finance, researching investor psychology and
groupthink would be of great interest. The thought process for an individual
during an investment is complex. The number of emotions combined with the
financial stakes creates a decision-making process worth studying.
At times,
investors can show a remarkable tendency towards herd mentality. This is
clearly evident in several historical markets and since then mainstream
investors have tried to capitalize on this behavior via the popular “contrarian”
strategy in investing. Most people feel instinctively drawn to an established
opinion, the consensus. People enjoy positive feedback and the feeling of being
validated by the majority who share a similar opinion. This phenomenon has been
well documented and can be seen throughout investment history: The South Sea
Bubble, Tulip Bulb Mania, railroad stocks, gold in 1979, the Tech Bubble,
residential real estate, etc. These are prime examples of investment groupthink.
To a lesser extent, this same mentality occurs outside periods of incredible
asset appreciation as well and it is particularly evident right now in regard
to the public’s perception of the United States Treasury market.
The immensely
popular investment idea, namely to short U.S. Treasuries, may be the largest
sucker bet in many, many years. Instead, buying longer duration government
bonds (U.S, European or Japanese) before the final stage of an epic 30 year
bull market could prove to be one of the smartest trades of the last decade. Although
buying Treasuries may or may not be the best trade in terms of sheer magnitude
of price movement, it will prove to be the essence of investing; finding
genuine value in a loathed asset and knowing when to part company with the
crowd. Buying Spring Wheat in 2005 or shorting crude oil in the summer of 2008
may prove more financially rewarding, but buying government bonds will be more
satisfying since very few believe in a potential advance.
In 2009,
the debate between inflation and deflation was fierce. Now it seems the general
public agrees that inflation hides around the corner due to massive money
printing. Marc Faber enjoyed comparing the United States to Zimbabwe and stated
that “Ben Bernanke appears to have Robert Mugabe as his mentor”. So far, we
have seen little evidence of any inflation; instead on the contrary, prices
have been falling. According to Bloomberg the financial crisis eradicated
almost $14.5 trillion dollars in wealth compared to the almost $3 trillion
spent in bailout and stimulus programs. Three trillion has not been nearly
enough to cause hyper-inflation in this environment compared to the contraction
in credit and wealth. The monetary base has exploded, but so has reserve bank
credit. The money isn’t getting out to the economy, and the velocity of money
(an important component to inflation) continues to shrink.
David
Rosenberg, Chief Economist and Strategist of Gluskin Sheff recently presented
some interesting data in regard to the average U.S. household balance sheet.
The data shows that U.S. households own $800 billion in Treasury notes compared
to $3.5 trillion in corporate bonds and municipal paper, $4.6 trillion of
consumer goods, $7.7 trillion of deposits and cash, $18.1 trillion of equities
(after the bear market) and $18.2 trillion in residential real estate (after
three years of dropping values). A quick back-of-the-envelope calculation from
that data shows that Treasuries make up less than 2.7% of total household
liquid (excluding consumer goods and residential real estate) assets and less
than 1% of total assets. Treasuries are clearly under-owned, especially in the
face of another downturn in equities when investors will demand safe assets.
For many
years now, traders and portfolio managers have been salivating at the idea of
shorting Japanese Government Bonds, citing the country’s high debt to GDP ratios
and history of quantitative easing. Japan is the real world proof that U.S. and
European government bonds can continue to move significantly higher and yields
can move much lower than anyone thought possible, even in the face of what
seems like unsustainable government debt. JGBs rose to a high in 2003 and that high
is about to be challenged again. That high in bond prices saw a corresponding
low in yields of 1.049%. If the yield on U.S. 10 year notes drops to the same
level the bond price would rise to approximately $146.00, a 24% rally from
current levels.
Some
trades are good enough to assume just from a contrarian standpoint. The basics
of a contrarian “play” is that when everyone moves to one side of the trade,
there are so few new buyers (or sellers) to get on board and maintain the price
movement that prices will swing the other way. The case for a contrarian trade
in government bonds is perfectly clear. CNBC and Bloomberg routinely have guests
and analysts making their all too common case for shorting government bonds.
The financial gurus (some of which I respect very much) like Jim Rogers, Marc
Faber, Peter Schiff and Nasim Taleb all preach the same trade. In fact, Mr.
Taleb recently stated that “every human should short U.S. Treasuries”, a
statement he will most likely regret for some time. Financial magazines such as
Smart Money and Forbes have published feature articles about the Treasury “bubble”
and impending high interest rates. Many financial bloggers and small
speculators love this trade as well, typically citing the previous sources for
their research. Even Pro Shares launched two Ultra-Short Treasury ETFs in early
2008, which would rise in value if U.S. Treasuries declined. It seems that all components
of a contrarian trade exist. At some point all these market participants will
be absolutely correct, government bonds will decline dramatically and interest
rates will rise. They are not wrong, just too early.
Lastly, from a trading standpoint, following the current price trend can often be prudent. Picking tops and bottoms is dangerous sport and general investors should avoid it at all costs. In managing the portfolio for MKC Global Investments, we require some degree of a rising market to be a buyer and a declining one to be a seller. Government bond markets fulfill this requirement as well. Treasuries declined over the last year, but are up over 2, 5, 10, 20 and 30 years. Needless to say, the trend is up. Very few people remember, or have taken the time to look up what a chart of the 30 year U.S. Treasury bond looked like when it bottomed in 1981. Above is that chart. Note how it began its bottoming phase with a massive spike down, a retracement of that decline and then the final largest descent to its ultimate low. Some people may think that the run-up in bonds 14 months ago was the blow-off stage of the bull market. Instead it actually shares the same qualities with the 1980 price spike that preceded the final leg down and ultimate turning point instead of marking it. The data indicates that bond prices could make new highs and not by a token amount either. The rally 14 months ago wasn’t fitting for the finally of a 30 year bull market. With that said, prices can easily decline for several months or even a year before moving higher. There may be enough ammunition from eager speculators initiating short positions to subdue any rally for a little while.
History has shown repeatedly that historic bull markets, lasting for many years, end in capitulation and a state of euphoria. The government bond markets have not witnessed that stage yet. As a market participant, due to the complexity of markets, knowing just half of the applicable fundamentals is great when planning a large trade. Any more is fantastic. For some, a convincing contrarian indication or a strong price trend is valuable and can be enough in itself to take a position. Right now, for the government bond markets, we are faced with a trade where the fundamentals, price trend and a strong contrarian component are in place. Buying U.S. Treasuries will be one of the greatest trades of this generation; do not be seduced into shorting U.S. government bonds too soon.
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Imagine a homeowner, wife, kids, 2 car payments, 2 mortgages, and just enough cash flow from work to pay the bills. There is not much leftover for food, gas, utilities, clothes, etc. He turns to credit cards to cover the shortfalls.
For many years, he makes a little higher than the minimum payments. Then the furnace goes so he has to finance it. Later the roof goes. Finance that too.
One day he finally realizes that his whole paycheck is going to pay the house, cars and minimum credit card payments. Food, gas, utilities, clothes, etc. are simply being paid by his ever ballooning credit cards. The government is no different. Same story, but no spending limit.
The writer sounds suspiciously like a Prechterite. I wouldn't touch 'em with a 100 foot pole. A strange breed of humans they are.
GOLD BITCHES!!
I am Chumbawamba.
Speaking of powerful men:
BlackRock Inc., the world's largest money-management firm by assets, has increased its holdings of Treasury securities in recent weeks in response to the unsteady outlook for growth, ongoing sovereign-debt woes and contained inflation risks.
Curtis Arledge, chief investment officer of fixed income, fundamental portfolios and a member of BlackRock's Fixed Income Executive Committee in New York, said in an interview that he has recently been "more constructive" on the Treasury market, moving the firm's Treasury holdings toward neutral levels from last year's underweight position.
http://online.wsj.com/article/SB1000142405274870386270457509972005121778...
If y'all wanna twist the 800-lb. gorrilla's nose, be my guest. Disclosure: I'm long Treasuries and happy to clip coupons while goldbugs and doomers rave about imminent default, Mad Max economics, and so on and so forth.
All is decidedly well, as long as total suspension of disbelief and 0%-.25% free money rampfest continues.
As rapier says- 'It is so, as long as the powerful men make it so, until it is no longer beneficial to them.
One eternal, or seemingly eternal thread of the the Treasury bear arguement is that supply will overwhelm demand. Supply and demand some might recall is an economic concept that is held dear by many. What goes unsaid when it comes to broad classes of financial assets it doesnt really apply. Or it sure rarely seems to.
Some might be aware that for 60 years one major political party and every member of our business elites have said government borrowing is an evil unto itself, unsustainable and had made America into a living hell. Many famous billionares devote good portions of their lives delivering these messages. Even a famous Fed chairman often said as much. Except at that time when the possibility that borrowing would almost disappear so he promptly adocated reducing revenue to insure more borrowing. At an rate the funny thing is the scolds never stop buying Treasuries. That doesn't mean it will always be so.
Back in the day when the Treasury needed money they went to JP Morgan to get it. Ah, those were the days. All JP's decendents have to do now is help torpedo Uncle Sams borrowing and Uncle Sam would only be allowed to borrow what JP's boys say they can and if JP's boys bonds were yeilding under Sams so much the better.
Well it is all frightfully complicated but at some point supply will matter because powerful men make it so.
shorting almost anything these days is a bad trade...stay long all the bubble plays and buy some gold...its not that hard.
Once UE falls, the Vigilantes will strike with vengeance.
Folks, the buy and hold in all asset classes is finished. If you think you can make money buying something and putting it on a shelf you will lose. That includes short Treasuries.
Everything has become a timing trade. TLT and all the other short Treasury options has a death trap in it. The negative carry (AKA the yield curve) will kill you.
For me this is the worst kind of by and hold. You lose money in it everyday from the carry. So only pros should play in this arena. If you hold this trade over a weekend you are just nuts. It is a day trade.
There will be a time (I think late summer) when this the TLT will be the right place to be for a bit. But there will never be a time when it is right to buy and hold a short bond position.
TLT is not a short treasury ETF. its a long treasury vehicle.
And still, I go shopping, and the stuff I eat costs 8% to 20% more than it did last year, or the portions are shrinking ala a can of coffee in the 1970's.
If you think inflation is tamed, you are misguided.
Historically, rapid expansions of the money supply have eventually resulted in at least some inflation farther down the road. I don't think long 10 year or 30 year treasuries represents an attractive risk/reward, from a yield or capital appreciation perspective.
MKC Global is Hugh Hendry, is it not?
The supply of 10-30 year Treasuries is at a 30 year low.
Food for thought.
Ben bought the HIGH
Here it is guys....
Once upon a time there were 10 world dominating economies....
When the polys of each country discovered that they could get elected by making promises to the people with their own tax money...backed up by being able to print and borrow money as well.....the death warrant of each economy was signed....
.................................
The smaller economies that tried to play the Poly game .....very quickly debased and over indebted themselves....It just took the bigger ones longer to do so....
.................................
Now the game is one of comparables....
ie In which damaged economy is big money safer ?
Well....here is the problem....
A rising tide....raises all LARGE ships....
A lowering tide....lowers all LARGE ships....
The little ships and boats....DO NOT MATTER
......................................
Bingo! The great vote buying ponzi is coming to an end.
I like the analogy, however a rising tide does indeed raise all boats. The bigger boats just hit ground first/float last. Still, good stuff.
The flip side is, who is better off when a storm brings 30 waves? Is the tide falling, or is the storm coming?
...or both?
good article,
but, boy that current spike looks tough to sustain.
it'll be interesting to see what happens after the Fed buying is done and the related buffers dwindle. it might be a little closer to a 'natural' market.
i'm definitely wary of any investment that's "the only place to go".
There is still this nagging little doubt in the back of my mind...if "the monetary base has exploded but the money isn't getting out into the real economy; ergo, we can't have inflation"is true, is it really money? What good will it do the holders if it is doomed to never be exchanged for real goods?
Maybe it is not even "money" anymore...
More and more of this is piling up in excess reserves, in continually rolled-over debt, in bonds doing nothing but collecting even more of that same stuff in "yield"...
It's all so divorced from the real economy. The temptation to 'spend' some of this will be overwhelming. Because the holders of these sums-of-whatever know very well that, only the earliest spenders will get good value for their paper...
I think the real sucker bet is buying notes and bonds of the largest debtor nation in the history of the world. As Jim Rogers has pointed out time and time again, it is ridiculous that anybody would loan the US government money for 30 years at less than 5%. It really is lunacy. The US has been issuing such huge amounts of debt and continually rolling over debt (which we all know they are never going to pay back) and yet prices continue to rise; this is a bubble.
Like another poster pointed out, this article totally ignores the Fed manipulation of rates. If the Fed wasn't buying up Treasuries rates would already be through the roof. Yet the author completely neglects the mention the fact that Karl Marx's 5th plank is a substantial contributor towards Treasury demand and even claims that the fundamentals are sound! What a laugh.
The US raised the debt ceiling by $1.9 trillion and you know what happened? Treasuries went up. I don't know what you call it, but I call it a mania. Treasury prices have been relatively stable for a long time now and this will not continue to be the case. The situation in Japan is not relevant; Japan, despite its debt, is still a net creditor nation whose population saves over 1/4 of their income. The US is the largest debtor in history with a savings rate of what, 3%? No comparison.
$14.394 trillion in national debt, $56 trillion in unfunded liabilities for Medicare/Social Security alone, and thus no chance of ever paying this back which means either default or hyperinflation in the future (may take 10-20 years though). Yeah, can't wait to invest in that financially sound success story. So tell me, do you work for the US government or did they get internet access at the insane asylum?
Unfunded liabilities won't be paid. That means that the former recipients of same must look elsewhere for money. The resulting defaults drive investors towards safe assets, like, say, US Treasury securities.
Increasing Treasury issuance creates fears of future taxation in the market. This increases savings which decreases risk investments. Since wealthy persons need more than mere FDIC insurance, they buy Treasuries. Supply creates its own demand.
The Japanese had savings and this acted as a cushion when Japan went into deflation. The US has little savings, so the defaults will be far more severe. Treasuries will, naturally, benefit as an interest bearing (for now, yields are going much lower) instrument that is safe from default.
People wish to believe that the market is lying to them or being "manipulated" or that their fellow men are insane. In general, they are wrong on all three counts.
Two things you didn't mention:
1: China is a buyer and will remain a buyer - it simply has nowhere else to put it's cash and it wants to keep the dollar high.
2: Pension funds and insurance companies have a requirement for AAA that is mandated by law - the supply of the "alternative" (i.e. toxic assets), is somewhat restricted at the moment.
Why does everyone keep saying yields are near zero? Yes, the short end yields very little, but the long end is pushing 5%. There is a heckuva lot of room between 5% and 0%.
Treasuries are the most hated asset class on the planet right now. By far. Am I a large buyer here? Maybe, maybe not. However, I'm definitely not selling short.
What kind of trade is that? If you are not shorting you should be long - not doing anything amounts to not having an opinion and you may as well NOT comment here.
I'm shorting treasuries for the simple reason that printing more money than economic growth warrants will at some point have an inflationary effect, which also comes in very handy for the US government as it effectively dilutes the huge outstanding debt burden they've gotten themselves into. I am not saying this will happen quick and soon, but it WILL happen.
Long term treasuries isn't a trade that will make you a ton of money, but I think there is something to it. The risk that the market for treasuries will quickly crater is relatively low - the main risk is slowly losing money to inflation while other assets such as stocks and commodities appreciate as the printing press cranks up. Not much different than holding cash at this point.
I've been on the deflation side of things for awhile now, and I'm steadily becoming more convinced that we will not be printing our way out of this. The market is operating as if too big to fail is still in effect... but the current political landscape won't allow another TARP. Even the Fed will face pressure to slow the press in the face of another failure, as printing money clearly didn't help the last time.
Thus, I'm bullish for long term treasuries over the next couple of years (disclosure: long TLT). But I do agree there is not a lot of upside - and longer term the risk of default is real.
BB quit printing? Hes an addict, no way can he quit, the other addicts wont let him.
The question for some is will he print enough? If credit (money) is the air rushing out of the hole in the money balloon, can Zimbabwe Ben print and blow in faster than the air (credit contraction) is escaping.
The real question is will the banks ever expand credit using all the newly "printed" money they have on reserve, that would effectively patch the hole in the balloon. When the new credit money starts to flow and grow that is when the inflation/hyperinflation kicks in.
There could be more upside to treasuries, but only because every other parking place for money is less secure or less liquid. The leper with three fingers is King -- until he dies of a blood infection.
treasuries are paper agreement, a check by any other name. Dont folks get the fact that agreements are not being honored or portrayed honestly?
Fool me once and i am georged and bushed
Fool me twice and get obombed and econned
Fool Me once...
http://www.youtube.com/watch?v=8Ux3DKxxFoM
I know that human beings and fish can co-exist peacefully...
Disclosure: I hold TBT based on trend following methods. Will get out when trailing stop is hit.
what a joke he was! however, the joke was on 'merica, not him. Bush has a photographic memory; most dyslexics do. He was neither stupid, nor brilliant, but extremely capable for 'head of state'; the perfect "puppet"...."[O]nce AirForce 1 was airborne the plane went up, and up, and up. It stayed in a holding pattern for hours, after receiving this message, "Angel is next." "Angel" is AF1's codename."
Interpretation; and after the destruction of the temple, the "son" ascended into the heavens.
Who knows which Bush slept in the White House on the eve of 9/11? Who knows which Bin Ladin met with said Bush at the White House on said date?
How much upside can there be? Rates are at historic lows, short rates can't really get any lower. I'd rather keep my cash under a mattress than take the counterparty risk for 4%.
This report is rubbish; it smacks of a position thesis for mkc global. 1) The author presents no valid fundamental arguments to support his positive bias. 2) He totally does not mention the FED manipulation in bond markets. 3) He does not mention the credit risk in UST's vs a good diversified portfolio of corporate & emerging market bonds. 4) He presents the same tired contararian seniment arguements on groupthink. Money flows into bonds of all stripes that offer higher yield & better credit risk than the US gov't. 5) He admonishes investors stating the market cannot be timed & it is best to buy UST's, yet we have had a clear corrective followed by a consolidation period indicating the upward trend is no longer decisive. 6) The bond chart he presents shows the standard chart patterns on it including the obvious "fry pan bottom" pattern. Thank you, sir for I have seen this chart many times as I lived through the events. Were you an adult during that decade?
Think for yourselves folks, weigh out the credit risks, interest rate risks & economic fundamentals & decide what's best for your portfolio. Please, no manipulation by pressing the fear buttons that this author uses. In the ZH forum area under equities you will find the current chart for TYX, the 30 year bond, not the 30 year old plus chart presented in this post.
So UST long-term yields are going negative, too?
Good to know. Well-written conjecture. Let us know how this trade ends up for you in two years.
A steadily rising UST would mean a steadily unraveling private economy, financial asset destruction, and political chaos.
Yes - UST will strengthen. Until the USD collapses. Its just another carry trade. Picking up nickels in front of a steamroller.
Shorting is dangerous because its all timing. Getting it right is mostly luck. But to think the UST can continue to strengthen in an economic apocalypse is lunacy.
A flight to safety is 'lunacy' ? TSY's up til DJ 5K, then they can crash.
All contracts, all paper is perishable.
Only PMs survive.
You can loot a burning building if you want to. I'll stay outside and watch myself.
I hope you, and anyone following your advice, are able to get out before the burning roof member known as inflation blocks the exit, trapping any left inside in a financial hell from which there is no escape.
I don't know why the hell you would want to go long Treasuries, with yields standing near zero. Even if everything is fine and dandy for the next thirty years, you make nothing. The yields can't go any lower, so no-one will ever pay you a premium for them. It's like competing with a over indulgent rich man to make a 0% interest loan his spendthrift, irresponsible son money for consumption. You'd be better off putting your money in CYB. Hell, you're better off putting it under the mattress.
TLT at support: declining wedge formation. If thesis is correct, breakout in price could occur quite soon.
Couldn't agree more with this post. The time to short treasuries was 14 months ago at the peak of the crisis. As a contrarian play, I've been accumulating TLT under 90. Check out a 10-year chart...and it yields 4% or so.
If the market crashes (as everybody here seems to think is imminent; I'm not so sure. I think a 5-10 year grind at current levels is what we're in for), then TLT will go back up into the 100's.
We all know BB's a liar, but I think he was telling the truth when he said interest rates are gonna be low for a long, long time.
I think that's the game. the catalyst to get short treasuries will be something else collapsing (piigs, equities, etc.) and that will be the time to get short treasuries, otherwise you'll the carry will hurt, and you'll get whacked when everyone piles into them looking for "safety"
you are betting on BB telling the truth for the first time! LOL Thanks haha yea , right , check is in the mail, hey , i got a bridge,,,,,
Agreed. The treasury market will be the last to collapse after all other markets. It will be an epic event, to be sure. But not until they have killed the stock market and the fiat currencies of all other nations.
All of my 401-K is Treasuries. I really have no other viable options.
Cash out your 401k. Put the money in a bank account or safe deposit box. Buy gold and/or silver. Pay off you mortgage. Etc. etc.
I look at 401k's like social security. Depending on your age (espeicially if your under 50), you probably will never see a cent from either, so you may as well use the money while you can still get it.
Logical and well stated.
Thank you for the clarity of your post.
Far too much "scariness?" these days.
Keeping ones's mind about oneself is profitable.
Panic is death.
JG
"At some point all these market participants will be absolutely correct, government bonds will decline dramatically and interest rates will rise. They are not wrong, just too early."
Captain E.J. Smith to the steerage passengers of the Titanic...
"Listen guys... sure the ship is going to sink but we've got plenty of time to get off the boat and some great hours of luxury left to enjoy! Heck... I'll even bet that those first class passengers are going to come back onboard. Let's pull up some deck chairs and I'll strike up the band... we can hit the lifeboats later..."
At some point or another, we're all expendable to the powers-that-be, just like those steerage passengers were when two thirds of the lifeboats were eliminated from the original design. Hell, if it really was unsinkable, why did they have any lifeboats to begin with? Just dead weight if the ship would never go down, right? Well, prudence dictates that just in case we gotta save the powers-that-be in 1st and 2nd class.
Funny how the cost of the 3rd class and steerage tickets were important but not their lives.