Tuesday, February 16, 2010

Where to Hide?

Any concerns within broader credit markets need to start with sovereign risk (per The Star).

The sovereign debt crisis contagion is spreading in Southern Europe, from Greece to Portugal, Spain and Italy, where government debts and budget deficits are high.

Investors have sold government bonds in those countries as perceived default risks have risen.

This has resulted in the rise in the yields of government bonds resulting in higher borrowing costs for the government and private sector as loans are often tied to the risk free rate of government bonds.
But that is not where it ends.

Since the remarkable comeback across all risk sectors following 2008's collapse (the illiquidity in TIPS during the crisis made them trade among credit risk sectors), corporate bonds (both investment grade and high yield), agency mortgages, and even TIPS have been under pressure.

So if you can't hide in credit, TIPS, or mortgages, where can you hide and get more than 0%?

I have a few ideas, but would love everyone's thoughts...

Source: BarCap


  1. this is a tough call... and believe me I have been thinking hard on it....

    I think a portfolio of 3 components can do the trick -
    1) 30% MLPs - provide solid yields in the 4-7% range but have equity volatility. Most MLPs are transit lines for NatGas - which will have a very certain future for US energy policy.

    2) 30% Can Royalty Trusts/Oil Sands - while transitioning due to changes in tax laws, these are the REITs of the oil world with massive dividends - again yielding 4-9%; but yes you have volatility of the underlying commodity (mostly oil sands). I think there is a floor at 65-70$ for oil (temp dips below in massive selloff) but you have opec and others to keep it in that "sweet" spot. So while it may be volatile it will yield.

    3) 40% Gold (ie ETF GLD) - studied gold a lot. Many ways to look at it but its a bet AGAINST currencies if anything. So when uncertainty persists (eg Greece/Dubai) gold will strengthen. So I am saying in a deflationary or even volatile/uncertain time gold should hold up - may not be perfectly negatively correlated to equities/growth cycle - but it may be the best we have. Bad news is negative carry - but the other 60% of my recommendations (MLP and Can Roys) will make up for that.

    I am heading in this direction for the non fixed income portion of my portfolio.

    ..none of this is a perfect but, depending on your macro/worldview, this may provide income with some upside potential during very volatile 2010.

  2. You graphed treasuries but then did not mention them, but they should be safe, whether or not they are optimal.

    It's critical to distinguish between sovereign nations that issue their own free floating currency and those associated with either currency unions or pegs (see Modern Monetary Theory which has been getting wider exposure). Euro nations are analogous to US states in that they don't issue their own currencies.

    Bottom line... US treasury bond yields are very likely to be flat or lower over coming years (whatever happens in the short term, month-to-month), just as occurred in Japan since 1990. Domestic versus foreign funding for the debt matters very little. Basically government spending creates the funds for the private sector to buy the bond issuance. See this for more details.

  3. great question! I have been betting that yield thru good security selection is the play of the decade. MLP, HY, non-agcy RMBS, CMBS, etc. Picking through the rubble for survivors and using yield to cushion volatility and hedge against inflation is the best that I could come up with.

  4. Treasuries were meant to show relative performance of these fixed income asset classes. I am completely torn with Treasuries. I think rates can rally due to:

    *Slower than expected growth
    *Flight away from risk assets (i.e. flight to quality)
    *Low Inflation

    Or sell off due to:

    *Massive supply coming due
    *End of quantitative easing programs

  5. Jake,

    Very good, and difficult, question. (And I agree with your analysis on treasuries!)

    My current solution is:

    1. Stocks with low volatility and high dividend. There are stocks paying 4-7% that have been in a fairly narrow range over the last year, and hence might be expected to keep their value if the market corrects further.

    2. Low investment grade bonds with short maturity. Boring but stable.

    3. CDs -- after reading the fine print. In many cases the penalty for early withdrawal is not too onerous, so one can get an ok yield and still not really have your money tied up for too long.

    Anonymous6:43's suggestion of MLPs is good. Energy will come back eventually, of course.

    Jim Fickett

  6. IMHO, neither of those sell off reasons will cause treasury yields to rise beyond possible temporary month-to-month spikes.

    * End of QE: The rate of QE buying has already been slowing with little effect on yields. If anything unwinds of current big treasury short positions (if traders lose patience in yields rising) could offset any potential increase from end of QE.

    * Supply: Unless private sector deleveraging trends stop, the treasury supply is just filling the hole created by the shrinking stock of private sector assets as debt is paid down or defaulted on. See this graph or read the link in my prior comment.

    I really enjoy your blog by the way -- thanks!

  7. well, you can indeed run, but you can hardly hide from the looming sovereign debt defaults.