Thinking About Treasuries and Interest Rates – Another Head Fake ?

We had another ugly day in Treasuries today, Wednesday, May 6th, 2015.

Here are the recent returns for the IEF (first column) and TLT (second column), the iShares Barclay’s Treasury ETF’s:

1-month:-2.19%, -7.71%

YTD: +0.53%, -3.61%

1-year: +5.41%. +10.47%

3-year:+5.66%. +10.88%

What makes me nervous, since the March ’09 market low, the hue-and-cry every month has been fear of rising interest rates, and yet that is the one asset class “directional” call that has been consistently wrong, absent the 2013 rise in rates.

Fundamentally, it is always easier to explain the markets in hindsight and with Treasuries and interest rates, the story has become clear. Greece and the European debt crisis, started the Treasury rally in 2010 and 2011, but you also have a Fed that – at least if you listen to the Chicago Fed President Charlie Evans – are loathe to repeat the mistakes of the 1930’s. That is still a surprising story line given the size and complexity of the US and International economies relative to the primarily agrarian economy of the 1930’s, but the Fed line, is the Fed line. Frankly I think the whole lot of them are horrible forecasters, and it is just my opinion, but I suspect that they use their public domain commentary for simply vetting market reaction, and they tend to talk out of both sides of their mouth. The hard money guys were still looking to raise rates as late, as late 2007, early 2008. Fortunately, Ben Bernanke paid attention to the capital market signals and ignored the hard-liners. (By the way, simply to clarify, it is always easy to criticize, and I’ve never built a forecasting or econometric model, so I should shut my yap, but as one of my favorite b-school professors used to repeat frequently to his Bond Management and Money & Banking classes, “If it is good in theory and not in practice, it really isn’t good in theory either.”

The other fundamental aspect to the bullish case could be the banking system reform, and the slow rate of credit creation since 2008. If you listen to guys like Rick Reider at Blackrock, both financial system leverage and total leverage are still below the levels of 2008. That could be in reason (amongst many) inflation and disinflation has been the norm since 2009.

Betting on rising rates since the March, 2009, SP 500 low print, has been like shorting the Nasdaq in the late 1990’s. As a long-only advisor, I heard constantly about the Nasdaq valuation in the 1990’s and how it wasn’t sustainable: I heard this at the end of 1995, after the SP 500 had risen 37.5%, and every year after as the SP 500 averaged a 28% per year return between the years 1995 through 1999.

As an advisor that learned a lesson about “reversion to the mean” the hard way, it sure seems like Treasuries are the only trade where “mean reversion” doesn’t seem to apply in the last 35 years. Even AAPL corrected almost 50% starting in late 2012, with the correction in the stock lasting about a year. (Long AAPL)

Something has to give – the one mantra when I have market discussions with clients is that “In the capital markets, every trend eventually changes.”

You look at the global central bank easing over the last 7 years, and I have to wonder “Will these coordinated central-bank policies ever result in a global-growth acceleration ?”, or the complete opposite of today’s malaise ? When you think about the 2008 US Financial Crisis, the European Debt Crisis of 2010, and 2011, and the completely mucked-up Japanese economy still staggered by debt and deflation, was debt issuance the only reason these economies grew from the 1980’s through the mid 2000’s ?

Today, the case to be long or neutral duration is well known. The case to be underweight duration is a fear that just hasn’t materialized over the last 7 years. Like the humorous cartoon read recently, “Did you hear that banging your head against a brick wall also burns 150 calories per hour ?”

For clients, I’ve been in a lot of cash, underweight duration in ultra-short duration funds, and owned the TBF off and on over the last years, and more on than off.

To be honest, I dont have a clue where the 10-year yield is going. It could trade back down to 1.85% again. The fact that the 10-year traded above the 2.17% October 16th high yield was technically positive for those short Treasuries.

But at some point, some how, some way, this 35 year bull market in Treasuries will end.

(I just had to write this to get it out of my system.)

(Long some open-ended mutual funds, muni high yield funds, and ETF’s, AGG and TBF)



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