Sunday, January 15, 2012

The Treasury Rally that Keeps on Trucking

The WSJ reports on the Treasury Rally that Won't Die:

According to investment-research firm Morningstar, a portfolio of U.S. Treasurys with an average maturity of 20 years—the quintessential safe haven—rose 28% last year, even better than its 26% jump in 2008. You would have to go back to 1995 to find a better year.

More confusing still: Last year's surge came in the 30th year of a historic rally. Since 1981, long-term Treasury bonds have returned 11.03% annually, 0.05 percentage point better than the Standard & Poor's 500-stock index.
This comes a full year and a half after the WSJ said Treasuries weren't only overpriced, but that we were experiencing The Great American Bond Bubble (my rebuttal 'Bond Bubble Blasphemy' is here, while my rationale for the value of Treasuries at the time can be found here).

One of the charts outlined in my post back then (and updated below, but brought back to 1941 using data from Shiller) shows the takeaway... treasury rates have been a reflection of the historical growth of nominal GDP going back 50 years. Before that there was a huge disconnect following the Great Depression (when nominal GDP dropped by ~50% between 1929 and 1934... yes 50%!) and World War II, which conveniently allowed the U.S. to grow out of the massive amount of debt the nation had accumulated.

By this measure, the 3.8% annualized nominal GDP growth over the past ten years makes the current sub-2% interest rate seem low, but not as much when you take the following into account:
  • Five year annualized GDP growth is only 2.2% (i.e. we are trending down)
  • The Fed has made it clear they won't be raising short-term rates anytime soon / they have taken significant Treasury supply out of the market with quantitative easing programs
  • Deflationary pressures / potential shocks from Europe remain
  • Investors continue to flee risk assets into "safe" assets
So, does that make me a buyer of Treasuries at these levels? Not necessarily. I'd rather take a barbell approach to investing by allocating to return seeking assets on one side (I'll never tell you where) and cash on the other (for preservation of capital purposes). 2% is just not worth it for me and the beauty of investing for the average investor is we don't have to manage our own investments to a benchmark. That said, I don't think Treasuries are ridiculously priced given the circumstances.


  1. I cannot imagine what will happen to the united states if china and all the countries and all investors the world over avoid the dollar. Interest rates would rise enormously and the federal reserve would be forced to buy bonds from the treasury to fund the government and pay interest on all of the governments bills notes and bonds. When the buyers for united states debt obligations disappears the whole system will come crashing down. This is the type of thing that peter shiff has been warning everyone about when the ability of the united states to pay its debts becomes clearly in doubt all the buyers for united states debt securities disappears overnight.

  2. The disaster you point to is one of the reasons it won't happen. China avoiding the dollar would mean they are no longer selling to Americans, their export partner (when you sell good to Americans, they pay in dollars). Why would they possibly stop doing this?

    For an in-depth analysis as to why the U.S. may be at risk, but for none of the reasons you point to, go to Michael Pettis: