Thursday, July 30, 2009

Might Treasuries Have Another Rally Left in Them? And Why It's OK to Own Them Even if They Don't

Please look at the chart of the yield on the 10-year Treasury bond for the past 2 years. The red line shows the 50 day (10 week) moving average of the yield, and the green line shows the 200 day (40 week) moving average. The other chart shows a multi-decade look at the rise and fall of 10-year yields. Who is to say that the wild and crazy peak of the yield in 1980 is not equivalent to the wild and crazy fall in yield in December 2009, and that an even wilder and crazier low in yields is coming relatively soon just as a higher high in yields came in 1982?

While history does not repeat, it has been said to rhyme.

One year ago, the recession either was not accepted to have occurred or was expected by most seers such as the ECRI to be a mild one. In expectation of such, the bond went into enough of a bear market that a "golden cross" of the 50 day ma above the 200 day ma occurred.

Now, the MSM has told us that the recession is over. Yet the yield on the 10 year is just where it was one year ago. The yield is also exactly where the 200 day ma was a year ago. The 200 day ma is now horizontal at around 3.1%. Those with a long memory and an interest in numerology will recall that the 10 year yield bottomed in the last Treasury bull market (2000-3) at 3.1%.

The DoctoRx system of chart analysis also gives weight to the fact that it took only about 2 months for the yield to collapse from about 3.7% to about 2.1%, whereas it took half a year to rise to that level. When the sharp move is in the same direction as the major trend toward lower Treasury rates that has been in force for nearly 3 decades, and price deflation and asset, real estate and labor under-utilization is pronounced, the conservative investor who has been directed toward the stock market takes heed of the chart.

Gary Shilling, an economist who has been bullish on lower Treasury yields for many, many years continues to be bullish. He stated recently that he expects chronic deflationary pressures in the U.S. and lower Treasury yields. He also stated in this interview that people don't buy long-term Treasuries for income.

I disagree with Dr. Shilling on this last point. Receiving 4% income now with a reasonable certainty of getting the (nominal) principal back later beats 1% from a bank now with no greater security of principal return. Do the math. Receiving 1% a year for 2 years turns $100 into $102. At that point, one would have to receive 5% a year for the next 8 years to simply equal what one would have gotten by taking 4% a year for 10 years.

After the first period of Treasury yields well over 10% during the Civil War, yields bottomed, but it took a lifetime till about 1941 to do so. So maybe yields have bottomed, but maybe they will stay low or go lower for longer than the herd expects.

In the meantime, at the bottom of the post-World War II stock market when "everyone" feared another Great Depression, the Dow yielded 7% in dividends (and then there were retained earnings) and both long and short term Treasury rates were around 2%. Companies that 10 years ago had low dividend yields and were viewed as growth stocks, namely Eli Lilly and Bristol-Myers Squibb, now have 10X or lower prospective P/E's and about 6% dividend yields. Perhaps by 2020, Microsoft and Intel will be so viewed.

So for technical and fundamental reasons, direct ownership of intermediate to long-term Treasury bonds probably makes sense for a great many investors who are afraid of the "risk" but are happy to own "blue chip" stocks such as Walt Disney or Oracle that yield 1% dividends and can be purchased from insiders in the companies at prices far above what the companies are worth under generally accepted accounting principles.

Copyright (C) Long Lake LLC 2009

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