As the world waits for a cooperative agreement within the European Union to save Greece and keep the union together, and as traders and investors anticipate the next move by the U.S. Federal Reserve and central banks around the world, one thing remains true…
U.S. treasury yields can’t get much lower.
Sure, they can go lower, and they very well may. But how low, and what is the end game? 0% treasury yields?
Maybe things will get so bad that investors will be willing to pay the U.S. Treasury to hold their money, resulting in negative yields.
Yields on some short term treasuries are already negative when we factor in inflation.
I prefer to be a realist and certainly recognize that the economic situation worldwide could still get worse before it gets measurably better.
But I also believe it will get better.
With that in mind, you have to honestly look at the risk involved in holding U.S. treasuries. Despite the United States monetary and fiscal travails, they are still considered a safe haven. Billions upon billions of dollars are parked in treasuries. But what happens when things do improve?
The need for safe havens like treasuries will subside. Money will flee treasuries in exchange for other more risky and presumably higher returning investments. As you may know, there is an inverse relationship between bond prices and bond yields. When bonds are bought en masse like treasuries have been the past few years, the price goes up and conversely the yield comes down. Periods like this have become commonly referred to as “risk-off.”
But a “risk-on” period means investors are willing to again invest in things that may be more risky, without the guarantees of the government, in order to achieve a higher rate of return. This generally happens when the economy is thought to be growing. There needs to be a reason to believe you can make more money in riskier assets rather than safe ones like treasuries. So as treasuries are sold, prices decline and yields rise.
Since the beginning of the financial crisis in 2008, treasury prices have skyrocketed as yields fell. A good barometer and graphic representation of this phenomenon is the iShares 20+ year Treasury ETF (NYSE: TLT) charted below. This ETF seeks to “approximate the total rate of return of the long-term sector of the United States Treasury market as defined by the Barclays U.S. 20+ Year Treasury Bond Index.”
The chart quite explicitly illustrates what has happened to treasury prices since 2008. The fear and uncertainty brought on by the financial crisis created a massive spike in treasury prices at the end of 2008. Prices eased toward the middle 2009, trading essentially sideways until the fall of 2010 when they spiked strongly again.
Since the spring of 2011 treasury prices have gotten ever higher and yields ever lower. The yield on TLT is only 2.77% today. And that’s on a portfolio of long bonds. It was in the spring of 2011 that “Bond King” and co-head of PIMCO Bill Gross sounded the bell to get out of treasuries. It was also at that time that I wrote my first article for Street Authority on the same topic. We were both a little early in our calls, but the writing is on the wall…
The positive outlook for the “improving” economy in early 2011 has yielded to downright uncertainty today, which brings us back to my premise. Things will improve eventually; hopefully sooner than later. And when it happens I would expect an ETF like TLT to fall, somewhere around $90 a share, as treasuries are sold in favor of risk assets like stocks.
So what can you do?
One thing would be to sell your treasuries, treasury funds and treasury ETFs. Another would be to short treasuries. But this is an advanced and riskier proposition. My preferred way to prepare for the eventual selloff in treasuries is to use inverse treasury ETFs.
In a recent issue of Barron’s magazine, famed investor Doug Kass, a money manager who has made many great calls including saying stocks would bottom in March of 2009, stated that this might possibly be the trade of the next decade. And I agree.
We also agree on which method to use — and that’s by buying the ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT).
According to ProShares website, TBT “seeks daily investment results, before fees and expenses, which correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays U.S. 20+ Year Treasury Bond Index.”
TBT is a leveraged ETF (2X), so it requires great confidence in the trade to use it. The chart below says it all…
The fund was trading for more than $70 a share back in 2008, before the financial crisis hit, and has plummeted to less than $15 today. It is quite conceivable that if treasuries return to their pre-crisis levels, bringing TLT back to around $90, then TBT could very well reach $60 a share or more, quadrupling your investment.
Risk to Consider: Treasury prices could of course go higher, and stay higher, for a long time. So as Mr. Kass pointed out, time is a necessary ingredient if you are to place this trade. Do not commit money to it unless you have a lot of time, and I mean possibly years. A worsening global economy in the near term means this trade may not pay off for a while.
Action to Take –> Short treasuries by investing in ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT). Eventually, the economic situation will be measurably better. And as things improve safe havens like treasuries will be sold. Prices will come down, yields will rise and TBT should provide a terrific, profitable result.
– Steven Orlowski
Steven Orlowski does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.