Peter Lynch said that any eighth grader could read a chart: simply determine whether the line was moving up or down. A close eighth grade appraisal of the chart of the yields on ten year US Treasury notes would reveal that yields are coming down. For the first time in over a year the yield is below 3%. Yikes!
A look back to the nadir yields of 2008 marked a low of 2.125%, and that was when the financial crisis reached its peak. Investors everywhere were stashing whatever money they had into anything that might provide safety. Reflecting on those terrifying days of yore, you might understand why so much buying pressure amid market panic may have driven yields so low, but what about now?
The obvious answer is the sovereign financial crisis in Europe. Greece, Spain, Hungary et al continue to struggle. We have been suggesting that these struggles are far from resolved because there is little resolve among the EU members as to what exactly they will do about problems in their neighbors’ economic backyards. A couple of times this year so far, the European Central Bank has made strong comments about their strong agreement to strongly address the economic weakness in certain member countries. The world has expelled a relieved breath and moved on in anticipation of some ECB or EU action or fiat. As we wait, the clock ticks, and the problems are not getting less problematic. As European problems seem stubborn, money is heading, once again, into the perceived safety of US Treasuries. We need, as the country song says, “a little less talk and a lot more action.”
I said the “obvious answer” in the previous paragraph, because I’m not at all sure that EU troubles are the only culprit. With each new monthly employment report, it becomes clearer that the 8 million+ jobs lost during the course of the recession are not returning any time soon. A second leg down in housing prices seems more and more likely as stimulus initiatives expire (and despite falling mortgage rates). There remains a huge amount of uncertainty regarding future tax rates and health care costs. Banks remain reluctant to lend as policymakers argue over regulatory reform. And this morning we received new indications that growth is slowing in China. Is it any wonder why investors are cautious?
Buy low and sell high. When bond yields are low, bond prices are high. This is as high as prices on the ten year have been in over a year. The price this morning is about $104.375 and the yield 2.98%. If we fully retrace to the all-time high price of $112.188 or a yield of 2.125%, traders might profit some 7.4% plus accrued interest. If we revert to the 12 month low of $96.1, traders would lose 7.9% less accrued interest. Why not flip a coin and be done with it? This is not a Comfortable risk/reward trade-off.
Our point is that while treasury prices may move higher (and that is their current direction) investors have precious little after-tax yield at 2.98% and not a lot of upside, so we would NOT be buyers at these levels. If the reason for holding bonds in a portfolio is added safety and stability, shorter, more defensive maturities seem in order. If you’re going to refinance or take a mortgage, lock in your rates now. These bond prices may go higher, but they won’t ring a bell at the top. Your best assessment of risk and reward is still required.
Hang in there,