Tuesday, August 11, 2009

More Life in the Bond Bull?

Please click on the chart of the yield on the 30-year Treasury bond for greater detail. The red line shows the 200 day moving average of the yield. Ever since yields peaked in 1982, there have been a series of lower lows and lower highs in this series.

A 200-year chart of long-term US Government bond yields or other highest-grade bond yields for periods when the USG had no outstanding long-term debt will show that the average yield is slightly above the current yield, at about 4.7%.

The cycle minima in yields have less of a correlation to whether the economy is in recession or not. Yields bottomed in 1982, 1986, 1993-4, 1998, and 2003 before last year's latest historic bond yield collapse.

At all points along this exactly 27 year series, bond bears came out and to date have been incorrect other than trading opportunities. One would daresay that the public has neither bought into the long-term disinflation camp nor has been greatly promoted it by the financial community. Rather, the public has been "educated" about "stocks for the long run".

Another major asset class which has received its share of promotion is gold. The average price of gold in 1976 was about $120/ounce. The annual compounded rate of return of the gold price is about 6.4% from then till now. A laddered bond portfolio of intermediate to long-term Treasuries has beaten this return with greater safety and no storage or insurance costs.

For those who believe that Treasury rates cannot go lower, remember that Fed funds have fallen 99% from 1980, from about 21.5% at the peak to about 0.2% now. If Fed funds can fall 99%, then the DoctoRx view is that there should be no intellectual problem with believing that bond yields can fall 90%. From a peak of 15%, that would mean that 1.5% is very doable. Of course, this is Japanese territory.

In other words, buyers of Treasury bonds will get their return, absent default, with the potential for price appreciation along the way. So long as the owner has no need to sell short of maturity, nominal principal is returned. Should interest rates surge, coupons at least can be reinvested at increasing rates; more adventurous investors can get a higher yield but no offsetting reinvestment opportunities by purchasing zero-coupon Treasuries.

Strategically, in a situation where it wants to sell lots of debt, the best situation for the US Gov't is to sell lots of debt as cheaply as possible. If you want to own fractional parts of companies which you probably know almost nothing about and have no control over, fine: own stocks, the more the merrier. But of course, these are used stocks that have been looked at by every brilliant financial mind in the world; the chance that you can find a "steal" is low. And every day trader and other speculator is looking at all the same stocks as you.

What essentially no private investors are looking to speculate in is Treasury debt. Thimk different?
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