Saturday, August 3, 2013

Long-Term Bonds vs. Short-Term Bonds

The following chart shows the spread between the 20-year treasury yield and the 5-year treasury yield. There's a missing data gap in the late 80s to early 90s, but it should not materially affect the conclusions.

Click to enlarge.

This chart contains two glaring linear trend failures. The first was a break from the long-term trend in blue (dotcom bubble popping). The second was a temporary break from the short-term trend in red (just before the full effects of the housing bubble were apparent to all).

Investors have been seriously burned twice so far (dotcom and housing) and it is my belief that if we are constantly told that treasuries are in a bubble, then investors will believe that treasuries must be in a bubble. Few seem to question what yields in Japan have done following their housing bubble in the early 1990s though. Nearly 5 years of ZIRP here haven't seemed to change many opinions either. Go figure.

Since 2001, there has been unprecedented fear of investing in long-term treasury bonds. That's what the red line in the chart tells me.

In 2001, the 20-year treasury bond yield averaged 5.63%. Many investors would sell their souls for that yield now (especially the ones who are still sitting in cash awaiting even higher yields). What will investors wished they had sold once the next recession hits? I'm going to suggest that it might not be today's 3.39% 20-year treasury bonds. I think there is a much more likely asset.

July 29, 2013
DEJA VU: People Are Using Borrowed Money To Buy Stock Like It's 2007 Or 1999

Deutsche Bank has a monster note out on margin debt that has been making the rounds. The conclusion of the note is rather simple – today’s euphoric borrowing on margin to buy stocks is reminiscent of past bubbly equity market periods (see here for more).

Just opinions! This is not investment advice.

Source Data:
St. Louis Fed: Custom Chart
U.S. Treasury: Daily Yield Curve Rates


Stagflationary Mark said...

I'm not suggesting that a 3.39% yield on the 20-year treasury bond is a screaming bargain. Screaming bargains are so 80s and 90s.

I am saying that it might not burn investors as much as investors think it will though, especially relative to other things. Many things can burn investors. In fact, some things seem to burn the same investors over and over again (especially since 2000).

dd said...

I'm still sitting on EE bonds from the 80's awaiting full maturity. It was from the screaming headlines of then a really stupid move but it was the best investment ever.

Mr Slippery said...

My fear of long bonds is not inflation, it is risk from a reboot of the international monetary system. I feel confident that will happen again, just like it did in 1945 and again in 1971. Using that time span, we were due in 2007, but I don't remember anything significant happening then (sarcasm!). I can't predict when or what will be the catalyst.

That said, I am forced to play the game with the current set of rules and I have over half my IRA locked in bonds that mature from 2014-2020. This is less risky than it sounds because my IRA is just a fraction of my pension (at least as promised). I don't work for Detroit.

Stagflationary Mark said...


Wow! Congrats! If I had the power to do it, I would offer you the "Balls of Steel" award. ;)

Stagflationary Mark said...

Mr Slippery,

I have no desire to exchange US dollars for Euros and then bury them in my backyard.

I have no desire to move from the US to China.

See? I can be optimistic. The US isn't so bad. ;)

Stagflationary Mark said...

As a side note, the only thing I feel confident about is that the European Union apparently only works well when there aren't economic crises in Europe.

It's like a fire department that can't actually handle any fires, lol. Sigh.

I am not awaiting an international monetary reset, although I could definitely see the Euro reset. Not predicting it. I'm just saying it would not surprise me. Perhaps I'm just desensitized to "unexpected" things happening in Europe. Take Spain for instance. Nobody could have seen that coming. ;)

Mr Slippery said...

I get the China vs. Europe vs. the US argument. The US is in bad shape but most places are worse. The dynamic I am concerned about is the US credit vs. imports. Especially oil imports.

I don't believe the US will ever run a trade surplus again. It hasn't since 1975 and gaps have grown larger over time. I also don't believe the US has found a dozen Ghawar sized oil fields under North Dakota and will never run out of oil.

At some point, I think the numbers will matter. 30 trillion in debt with a 2 trillion trade deficit? 50 trillion with a 5 trillion trade deficit? Some day, our creditors won't take any more dollars in trade. Maybe that is a 100 years from now and so for you and me, it won't matter. Heck, I might not even make it until the 32-bit Unix time clock resets on January 19, 2038, but I know it is coming.

Mr Slippery said...

FYI, the reset I envision is not just a redefinition of the US dollar. It's where the leaders of all the nations come together, like in 1945, and decide what kind of money system they are going to set up going forward.

That doesn't mean dollar become worthless, through it might mean they become worth less. The terms are particulars will be worked according to the relative strengths of the trading blocs involved. Breaking up the Euro may be part of that negotiation.

Stagflationary Mark said...

Mr Slippery,

Maybe that is a 100 years from now and so for you and me, it won't matter.

Yeah. Let's just say that although I like TIPS, I would not be interested in infinite maturity TIPS bonds.

There is no safe store of long-term value. Sigh.

Stagflationary Mark said...

Mr Slippery,

FYI, the reset I envision is not just a redefinition of the US dollar. It's where the leaders of all the nations come together, like in 1945, and decide what kind of money system they are going to set up going forward.

Perhaps, but I think it is less likely. It was easier to come to an agreement when one side was forced to concede.

If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem. - J. Paul Getty

I'm fairly confident that we won't be forced to concede any time soon. We're more than happy shipping dollars.

That said, I believe that some of what you suggest is already happening, especially to those who are sitting in 3-month treasury bills for the past 4+ years. Even interest bearing dollars are becoming "worth less".

As for the trade deficit, the recession did make a dent in it. Perhaps the next one will too. Yikes.

One thing we could do to reduce our trade deficit is to simply drive far less as a society. We will drive less if need be. I have no doubts about that. Maybe a lot less. Hopefully it is by choice and not by necessity.

Of course, that will add its own set of problems. There are a lot of people put to work because we drive so much (manufacturers, dealers, repair shops, and so on).

May we live in interesting times.