Monday, December 17, 2007

Historical 10-Year Treasury Note Performance

This is one of my favorite topics as you can probably guess.

This is a chart showing how we would have done buying the 10-year note and holding until maturity. It ends in November 1997 because notes purchased then would be maturing right now (and we can use the last ten years of inflation data to see how we would have done).

I've showed similar charts in the past. This time I have a few more charts to think about.

This is how we would have done had we simply gone shopping based on the nominal yield we were offered. The higher the nominal yield, the better we would have done in general. Note that the current yield on the 10-year treasury note is just a hair over 4%. That does not inspire confidence that it will be yielding a great deal of profits. It could of course, should we experience a severe deflation. I'd just be wary of betting on that outcome personally.

Now let's talk about how the above chart is actually two entirely different eras.

This shows an era when interest rates and inflation started off very low and generally rose over time. Note that for roughly two decades the 10 year treasury note was a relatively bad investment.

This shows an era when interest rates and inflation started off very high and generally fell over time. Note that for roughly two decades the 10 year treasury note was a relatively good investment.

The 10-year treasury is currently yielding just over 4%. That doesn't look great on either era's chart. This is one reason why I'm willing to predict the death of real yields. I might be wrong, but I think it is going to be very difficult to actually make money in the future.

Let's do some quick math using the treasury market's own data to predict the 10-year treasury note's expected 10 year profits as of 12/14/07.

The 10 year note yields 4.24%.
The 10 year TIPS yields 1.90% (plus inflation as time goes on).

That puts the expected inflation at 2.34% per year. If you earn 4.24% but pay 35% taxes, that's an after tax growth of 2.756%. You will lose 2.34% to inflation though. After 10 years you will have earned 4.1% in total real after tax profits. That's pretty much in line with the extrapolated red trend line in the bottom chart. That's the good era's chart though. If we slide into the bad era's chart, oh oh. We could be looking at some serious losses.

This is not investment advice. The deflationists could be right. I'm just suggesting that they've got some serious kahonies to be that sure they are right.

I also want to point out how we will probably react if inflation and interest rates rise. We probably won't be thinking in terms of positive real yields. The aftermath of the 1970s ended up providing real yields simply because inflation fell. Inflation is not guaranteed to fall. It might stay uncomfortably high for longer than any of us could possibly imagine. Past performance is no guarantee of future results, right? Further, if inflation does fall that doesn't necessarily mean we will know it in advance. I suspect strongly that low real yield expectations, once established, would therefore remain low.

I also want to add that the 10 year TIPS isn't going to perform any better if the market truly understands the next 10 years worth of inflation with its prediction. However, if (big if) the market should be wrong and both inflation and interest rates do rise, TIPS would be vastly superior to nominal 10 year notes (as TIPS are tied to the inflation rate).

As owners of TIPS we should want to be wrong. We still want low inflation (if only so we pay less taxes). It is kind of like having homeowner's insurance. Just because you have it doesn't mean you pray for your house to burn. Those holding nominal treasuries would outperform us, but we'd be doing okay. We therefore would relish being wrong. We'd love to be wrong on almost everything in fact. It would be so much easier to protect ourselves. Inflation hurts everyone.

Source Data:
FRB: Selected Interest Rates
St. Louis Fed: Consumer Price Index for All Urban Consumers: All Items


Anonymous said...


I-bonds would have been best here given the uncertainty. Tax deferral is a great equalizer over time. It appears our government is more financially shrewd than most. There are no more five dollar tables at this casino.

Stagflationary Mark said...

I'm really questioning my stagflationist views today, not that it affects my investments. It might just let me sleep better though.

1. Caterpillar just got downgraded. I owned it from about 2000 to 2004. It was a stellar performer during the 1970s. Perhaps its deep cyclical nature is finally appearing.

2. Greenspan finally sees stagflation.

3. Oil doesn't seem to agree with Greenspan today. It's down.

4. The US Dollar has been doing well for three straight weeks.

5. Inflation expectations as seen in the treasury markets remain nearly constant (on both up and down stock market days).

I would be very happy taking nearly constant inflation expectations with me to the grave by the way.

Then again, 1974 was but brief inflationary relief in an otherwise awful decade, if you can call one of the worst recessions in the last century relief that is.

Should we get another recession, it is what happens after it that concerns me most.

Anonymous said...


The 1970's were truly awful. Both equities and bonds took a beating in real after tax terms. My main take away from that period is that you must protect your nut as best as possible from inflation and taxes. As I see it, imputed gains are the key. Its just to hard to out run inflation and taxes.

By the way, Dr. Copper is talking again.

Stagflationary Mark said...

Dr. Copper is indeed looking a bit sickly.

Conclusion: If I had to pick a hard asset class to hoard, I'd probably go with silver again. However, I'm not looking to hoard hard asset classes right now. I'm stagflationary but in a treasury inflation protected securities way (since I can't seem to choose between deflation and inflation, but think slower growth is coming).

Silver is up. TIPS are up.

Conclusion: I'm not much of a believer in the current copper story.

Copper is down.

I didn't do half bad with that in hindsight. We can't all be hedge funds though, and with 9,000 of them competing with each other, I'd prefer to stay the heck out of their way, lol.

Anonymous said...

I'm sure you know this, but many people view copper as an excellent leading indicator of economic growth. The fact that copper is now falling would be viewed as negative. Combine this with last weeks ugly inflation data and your stagflationary view appears solid.

I'm not so sure anything works as an indicator here though. We are boldly going where no man has gone before. NCC-1701 if I remember.

Stagflationary Mark said...
NEW YORK, Dec 6 (Reuters) - With little relief in sight for a slumping housing sector that consumes a quarter of U.S. copper demand...

I haven't been all that bullish on lumber either. Go figure.

Anonymous said...


First let me say, I have no idea what the future holds for any investment. Especially commodities, which I view as volatile and risky.

I have studied timber a bit though and generally view it as a good long term investment. First, unlike many commodities, a good timber investment has a land component which can and does increase in value over time. Secondly, when when lumber sales are depressed, the timber continues to grow thereby increasing in value. Thirdly, even though some timber companies are structured as REITS, portions of their dividends receive favorable tax treatment (15% rate).

For better or worse, some of the timber companies decided to become developers during the housing boom which makes evaluating the companies a bit trickier.

Anonymous said...


Two thoughts:

1) I like the insurance reference. I used it myself in fact convincing my parents to buy the max limit of I-bonds before the year end change. As insurance goes, they are pretty cheap. I figure one is giving up about .5% in yield vs. a bank CD, and get to defer the taxes while waiting-out whether the s-word or the d-word comes next. There's not many investments one can be wrong about and the losses are only of the oppr. cost kind. My parents, a few years yet from retirement, certainly like that.

2) The thing that makes the present so hard to invest is that the housing bubble has ruined the easiest, most obvious option in a stagflationary environment. In fact, between that and the demographics of now vs. the 70's I'd say choosing housing and its ancillary commodities, like copper and lumber, as a stagflation hedge will be very disappointing to many a baby-boomer. I expect to often hear, "but it worked so well last time!?!"

Anonymous said...

Allan f,

I agree. It is different this time. In fact, I think its always different.

The huge debt outstanding from the credit boom and demographics associated with the baby boomers make today vastly different than the 1970's. WORRISOME to say the least.

All the older people I have ever known have become risk averse in retirement. Look no further than Stag Mark's bio and choice of investments for anecdotal proof. Stag Mark is not old and is clearly very capable. This is not an insult. Return of capital becomes more important than return on capital as one ages and retires.

One whiff of a bear market and many will get out of dodge and with good reason. Monte carlo simulations of losses during retirement are scary. A 25% to 40%loss over a multi-year period while drawing down principal and living with inflation is something from which most can simply not recover.

Stagflationary Mark said...


I should have made a distinction. I'm bearish on lumber but not necessarily bearish on wood.

Part of me thinks having a fireplace might be very desirable in the coming years and that perhaps I should think of gathering the fuel right now.

Stagflationary Mark said...


In fact, between that and the demographics of now vs. the 70's I'd say choosing housing and its ancillary commodities, like copper and lumber, as a stagflation hedge will be very disappointing to many a baby-boomer. I expect to often hear, "but it worked so well last time!?!"

One reason I sold gold and silver in 2006 was because I felt like I was hoarding "stuff" when the nation is already awash in stuff. There's clearly a bit of deflationary thinking in me screaming to get out.

Further, there's no proof gold offers the same level of stagflation protection it did $500+ ago (when it was $250 an ounce). It has vastly outperformed the price of canned goods for instance.

Stagflationary Mark said...

All the older people I have ever known have become risk averse in retirement. Look no further than Stag Mark's bio and choice of investments for anecdotal proof.

Indeed. I know how I have changed over the years. Risk aversion steadily increased. Each year without a job will do that to you.

The first year of retirement I was willing to take more risks. If I lost, I could reenter the workforce easily.

The eighth year is another matter entirely. Not many employers would like to see the employment gap on my resume. Further, I'd only be trying to go back to work more than likely because the economy nose dived and took me with it. The imagination runs wild when contemplating how many people I might be competing with for a good job.

Here's some seriously lousy advice by the way, and it is apparently aimed directly at me.
The financial services industry and the media have apparently done a good job of persuading people that they need to save more for retirement and frightening them that their nest egg won't last.

Yeah, it wasn't the dotcom bubble that did it. It was the media offering bad advice apparently. So why am I listening to this "media" story now? What's the harm in saving too much? Why do you want to stop me?

But some retirement experts believe you still need to take a bit of risk with your portfolio in the early years of retirement if you want that money to last as long as you live.

For those who did not save too much, apparently the way to make it up is to take on more risk. Let's talk about my early years of retirement. I was riding out the dotcom bubble in white knuckle mode and I consider myself fortunate that I survived it. These days people can ride out the housing bubble without me. How anyone can think a housing problem will be less severe than a dotcom problem escapes me.

Baby needs new shoes though. Lucky 22!

Anonymous said...

Retired for eight years at 43! Inconceivable.

My neighbor retired at 45 so he could spend time with his teenage kids before they left home. He's back to work now, but insists it was the best idea he ever had.

I wouldn't sweat the eight year gap either. It demonstrates achievement. A feat few can match.

Stagflationary Mark said...


When I applied for work at my last company in ~1991 I told them that it was my plan to retire early. I'd do whatever it took to see that happen. I think they must have believed me because they gave me the job.

I worked long hours as a lead software engineer (and was granted stock options). One of my products made it to #1 in Consumer Reports. As an investment though, that went nowhere due to eventual fraud (Cendant). I lost a lot of paper money the day it was revealed the books were cooked.

I also poured as much as I could into the stock market. In 1997, I bought my first house. In hindsight, that was a great year to do it. I probably have my sister to thank for taking so long to buy my first house. She owned a property once that ran out of water. Home ownership isn't nearly as cheap as the real estate professionals want us to believe. I was quite happy renting and very nearly decided recently to become a renter yet again.

The thing that retired me was driving a Hyundai while investing in a small private card game company run out of a basement. Rather than use the money as a downpayment on a new car, I poured it into that company based on the game they had developed but had not yet hit the shelves. I really, really liked the look of it. The company went on to sell over a billion cards. Go figure!

It wasn't really my intent to retire THAT early though. I wanted more of a buffer. Most people would not even consider retiring with as little as I have at such an early age. However, my job had turned so miserable in the aftermath of the fraud that it was seriously affecting my health. I knew our division was a sinking ship (it eventually sank about 5 long years later). I walked and burned at least some of my bridges on the way out the door. In exchange for retiring early (which I never regret), I simply live more frugally than I once imagined that I would.

I was 80% in the stock market heading into the dotcom crash. Fortunately, I had a diversified mostly old school portfolio of stocks nobody seemed to want much (especially Cramer, lol). Had I ridden all my investments out until today I would have had enough money to retire yet again.

The company that would have done it was Hansen. I bought it when it was $4 just because I liked the look of it at Costco. It was the last stock I owned in 2004. It had gone up six fold. Look what I missed though. It went up another 24 times after I got out (and became the poster child for small cap stocks it seems). Good grief.

In 2004, after exiting the stock market, I soon realized that I didn't have much protection against inflation. I therefore bought a good chunk of precious metals (held until 2006 and once again seem to have sold too early). I liked that they had been in a bear market for two decades. I figured the downside wasn't all that big.

I need to see serious bargains before I press my luck any further. I'm all out of investment ideas for the most part.

The first stocks I sold in 2004 were the financials and was the reason I turned bearish. It took three full years to be redeemed on that call. At the time, I expected them to lead the way. I still do. Could be wrong of course! I also sold Caterpillar in 2004 (after it doubled). I had no idea the Fed would put so much effort into their inflation efforts. It went on to double again after I got out. That being said, Caterpillar's recent weakness also explains some of my short-term deflationary mood.

I've also had plenty of opportunities to be completely and utterly wrong. I've owned HealthSouth, Conseco, and Nortel in the past. I bought Nortel at $11, watched it go to $100, then sold at $1 for the tax write off, lol. I thought Google looked too expensive at $291 and joked that I'd short it with everything I had (which in hindsight would have ruined me had I done more than joke about it). Thank goodness I believed in not putting all my eggs in one risky basket. When I say I could be wrong now, I most certainly mean it. I've got no crystal ball. Much of my wisdom comes from simply parroting Warren Buffett. I'd normally not put so much of my portfolio in one investment (TIPS), but Warren Buffett said that they weren't a bad investment if we're worried about inflation. I'm always worried about inflation (even when I might not need to be).

Anonymous said...


I find the whole Warren Buffet thing fascinating too, but have a different view/conclusion than most. Personally, I can't believe there aren't more Buffets.

The virtues Buffet espouses apply to all, but yet his results don't. My question is WHY?

Admittedly, Buffet had the benefit of using other peoples money, albeit very wisely. Something most do not. This is leverage. Investing was his job. To me, he was in effect receiving an early form of stock options in lieu of a true salary which he never cashed in and on which he never paid taxes. Further, while other companies were paying out dividends which were taxed at high rates, Buffet was re-investing in depressed valuations. If a particular business couldn't re-invest excess cash adequately, the cash was diverted to another business. All work and no play.

Through value investing, Buffet always avoided mistakes. Safety first. No get rich quick schemes. Imputed gains and compounding were key. Frugalness in his personal life and no extravagance in the companies where he invested. Over-paying of executives or dilution through massive stock options? NFW! Any potential extravagance was channeled into re-investment. Common sense and long term focus in an era of foolishness.

The result, 22% compounded annnual returns in an era of 11% returns from the averages.

To me, the amazing thing is not Buffet's success, but the fact that his success wasn't repeated by hundreds of others. No doubt longevity of purpose was crucial to his immense success.

In parallel to Buffet, consider a hard worker saving 15% after taxes and investing in the total market at say an 11% return. Very, very good results. Throw in a little effort to find value and avoid overpriced wall street crap and it was there for the taking.

Perhaps an industrious, patient and clever person can still do well today. Maybe the cost of keeping up with the Jonses is higher than most can fathom.

Stagflationary Mark said...

Maybe the cost of keeping up with the Jonses is higher than most can fathom.

Perhaps if prices were listed in terms of work hours some might rethink their priorities.

If I'm paying $5 for a beverage, I consider it a very rare treat.

When I was working and making relatively good money I was not quite as frugal, but I still had one rule I tried to live by. I'd have to think about an item once for every $50 it cost before I'd even consider buying it.

My last car was purchased in 1996. It was a Camry XLE. I figure I thought about that car 600 times before I made the purchase (driving a Hyundai will do that to you, at least back then, lol). It still runs fine. It has about 75k miles on it. I haven't even reached the $50 level on my next car yet, nor do I expect to anytime soon.

To replace it could easily cost me six months to a year of my life. For what? The new car smell? The ability to pay more for insurance on the depreciating asset? No sir. I find much more comfort in a half-priced paperback and a trip to the hammock (or replaying an old game on the Playstation 2!). If time is money, then I choose time.

Should a downturn come in our way of life, it helps that I love rice and beans and consider the best things in life to be free anyway.

Freedom (from debt) is a very liberating feeling. Too bad more people who have the means to be debt free don't realize just how liberating it can be. But hey, maybe that's just me. If people are truly happy keeping up with the Joneses, more power to them.

Anonymous said...


In a way you're a Buffet. Doing your own thing while everyone else basically wanders in the same herd - work, spend, work, spend, work, spend (all the while paying taxes).

Statistically, a 35 year old retiree is a five sigma event.

I'm sure Buffet doesn't wait in line at the Starbucks in the mall. But some times you just can't resist a $5.00 venti, triple threat, bruise on the inside, karate man, afrisudicana, mocha, frappa, whipped, pumpkin, carmel, nutmeg, frozen capalatte. All in an Exxon Valdez II, anti-spill, double hull, plastic vessel of course.

Stagflationary Mark said...


My $5 beverage indulgence would be a fruit smoothie or a decadent milkshake. I have apparently acquired very few acquired tastes.

My beer preference is root beer. I'm not fond of coffee. As for cigarettes and cigars, my favorites were the ones sold at Stuckey's. I can still remember the taste of the banana bubble gum cigars. The only time I'd get them was if we were on a trip across the state.

Here's a trip down memory lane. Good times!

Candy Cigarettes... In the new millennium they aren't called "cigarettes" any more... they are now "candy sticks."

Figures. There's probably a politically correct analogy here. Candy cigarettes are to candy sticks as government approved torture is to [insert something warm, fuzzy, and "patriotic" here].