If you were lucky or smart enough to buy U.S. Treasuries years ago, when those bonds were yielding high single-digit returns or higher, then there is no reason to sell them now.
However, if you have new money to put to work, should you avoid U.S. Treasuries? Probably, as spelled out in my column for the Philadelphia Inquirer.
Short- and longer-term interest rates essentially didn’t move in 2012. While there were fluctuations, short-term interest rates remained close to a paltry zero level, with longer-term Treasury bonds yielding just 2.5 percent to 3 percent.
America’s fiscal and monetary policy is also less supportive of bond prices, says Columbia Management’s Gene Tannuzzo, a senior portfolio manager. The Federal Reserve props up Treasury prices by acting as one of the biggest buyers, and Congress can’t agree on how to cut deficits, which means we have to issue more Treasuries to pay for all of our entitlement programs.
In descending order of attractiveness, Tannuzzo likes these bonds instead: bank loans, residential mortgage-backed securities, high-yield corporates, emerging market bonds, and investment-grade corporate bonds, which compensate investors for the assumed risk.
However, sovereign bonds, including U.S. Treasuries and what are known as agencies, such as Fannie Mae and Freddie Mac bonds, “no longer pay investors for the risk they take,” he adds.
We asked Ernie Cecilia, chief investment officer at Bryn Mawr Trust, what he would advise a client with, say, $100,000 or more of new money to invest right now.
First off: stocks or bonds? He leans toward equities, since yields on bonds are so low right now. The 10-year U.S. Treasury, for instance, yields just 1.86 percent, which doesn’t even keep up with inflation of about 2 percent to 2.5 percent annually.
Despite improving fundamentals, U.S. capital markets should remain volatile, given America’s continued structural deficits. However, a slow improvement in our domestic economy and in various global economies should result in a relatively more favorable backdrop for equities. Corporate cash coffers are flush and, Cecilia says, “we continue to see strong dividend growth from well-capitalized franchises.”
Domestic stocks, with strong business franchises that can drive earnings growth, plow back retained earnings into their businesses and have attractive valuations, such as T.J. Maxx owner TJX Cos. (symbol: TJX). Cecilia also likes mutual funds such as Lazard International Strategic Equity Portfolio (LISIX), and with developing nations resuming higher growth trajectories, Oppenheimer Developing Markets Fund (ODVIX).
“Given the absolute level of interest rates, we see headwinds in the bond market and below-average returns in 2013,” Cecilia adds. Finally, when interest rates do eventually rise, bond prices, which move inversely, will start to drop.
The tiny Swiss bank Wegelin & Co. pleaded guilty this month to conspiring with U.S. taxpayers to evade income taxes. But unlike HSBC, UBS, and other bank giants, three Wegelin officers were charged with criminal offenses.
UBS set up secret accounts for more than 20,000 Americans – hiding more than $20 billion in assets – but paid a fine and kept on doing business. HSBC also just paid a fine without prison terms for officers, after admitting to moving $881 million in laundered drug proceeds for Mexican and Colombian dealers.
Robert Mazur, a former U.S. federal agent who writes about how banks launder billions of dollars, thinks something is fishy about the Department of Justice letting big banks plead guilty to money laundering without anyone going to jail.
Mazur was an undercover agent who infiltrated the Bank of Credit & Commerce (BCCI) as well as Pablo Escobar’s Medellin cartel and the Cali cartel. You can read more about big bank money laundering in his book: The Infiltrator: My Secret Life Inside the Dirty Banks Behind Pablo Escobar’s Medellin Cartel (http://the-infiltrator.com).
What should we own in this bizarre period of ultra-low interest rates? Probably not Treasury bills and bonds, in part because they have gone up so much in price already. That’s what I wrote for today’s Philly Inquirer:
Currently, we are experiencing an unprecedented time of hyper- low interest rates on U.S. government Treasuries, alongside a historically massive budget deficit. So the Federal Reserve, which sets interest rates for the nation, is stuck: It can’t raise interest rates without increasing the U.S. government’s own interest payment and borrowing burden. But the Fed is de facto “taxing” savers by keeping interest rates low on those of us who hold savings in Treasuries.
Moreover, the Fed has become the biggest buyer of U.S. government debt, amounting to a rigged market. In calendar year 2011, the amount of net debt issued by the Treasury was $1.1 trillion, and the Federal Reserve purchased $730 billion in Treasury bonds.
As a result, smart money investors are starting to trickle out of the Treasury market and into stocks. Coincidentally, what we are witnessing right now is the rally in equities, known as a “melt-up.” A local financial planner explained it to me this way:
“For my clients,” said James Cox, a financial adviser with Devon Financial Partners in Wayne, “we bought Treasuries in January 2011 and sold them in September 2011. We then reallocated to equities in September and October. With a 15 percent correction, many quality companies were on sale. I expect to hold these positions for the next six to 12 months. I am amazed that the market is at the level it is with the 10-year yield until recently under 2 percent. It is my belief that the macro situation does not merit a 2 percent yield.” In other words, the yields should be higher.
Furthermore, “when people rush to exit Treasury positions they bought â ¦ to avoid a capital loss, it causes markets to ‘melt up,’?” Cox explained. (Devon Financial Partners specializes in planning for local business owners, families, and professionals, but is also an agency of the Guardian Life Insurance Co. of America).
For those do-it-yourselfers out there, here are a few options: Do as foreign banks, investment banks, and some big mutual funds are doing and start selling your Treasuries.
T. Rowe Price issued the following to its clients: “With Treasury yields at historically low levels coming into this year, managers say these securities carry significant interest rate risk and caution that longer-term Treasuries may prove most vulnerable to a reversal in performance, especially if the U.S. economy continues to only modestly improve and fears of worst-case scenarios for the euro zone prove unfounded.”
Most expect the yield on the 10-year Treasury bond this year to rise from about 2 percent to possibly 3 percent, which would result in about a 10 percent decline in principal value. “People always ask me if there is a bond bubble, and I say, ‘No, I think there is a Treasury bubble,’?” says Mike Gitlin, the firm’s director of fixed income. “To find real value in longer-term Treasury securities at these recent yield levels, one would have to have an extremely negative view of U.S. growth prospects, which is not our base case.”
Second, if you care to speculate on a potential downward price trend in Treasury bonds, you can do so using exchange-traded funds like ProShares UltraShort 20+ Year Treasury (symbol: TBT). These ETFs allow you to make a wager that Treasury bond prices, which were the best-performing sector last year, will start falling, but they can be quite volatile and risky.
Finally, if you’re a more professional trader familiar with and suited to what could be the borrowing of thinly traded securities, you could also short the Treasury ETF itself, such as Vanguard Extended Duration Treasury ETF (EDV), which holds only long-term Treasuries. PIMCO, Barclays iShares, and Schwab all have similar ETFs..
There are also leveraged ETFs that short the Treasury market for you and amplify your bet with borrowed money: the Direxion Daily 7-10 Year Treasury Bear 1x Shares (TYNS) and Direxion Daily 20 Year Plus Treasury Bear 1x Shares (TYBS), as well as the ProShares Short 7-10 Year Treasury (TBX) and ProShares Short 20+ Year Treasury (TBF).
Some money managers avoid Treasuries altogether. “We just don’t own them,” said Jim Dunn, a Philadelphia native and Villanova grad who is now Chief Investment Officer of Wake Forest’s university endowment fund.