When Smart People Are Wrong, Sort Of

It appears that even more smart people have been seduced by the ‘deficits, debt, and inflation’ meme:

Marc Faber recommends that investors flee 10 year U.S. Treasuries.

Doug Kass tweeted recently that he was “pushing hard” on his long TBT ETF (hat tip).  TBT is the ticker symbol for ProShares UltraShort (~2X inverse) Barclay’s 20+ Year U.S. Treasury ETF.

Options Monster reports significant call buying in TBT (buying opening calls in TBT means an investor is betting on higher Treasury yields).

As expected, Black Widow II is busy spinning its web in the U.S., and could end up sucking investment capital out of some talented hands.  

However, we wrote that these smart people are only sort of wrong, because on a tactical short run basis, these trades seem likely to work:

• The recent spike in market pessimism was sharp, sudden, and probably overdone.
• Reaction to Federal Reserve officials’ mention of quantitative easing (“QE2″) was probably overdone.
• If pursued, QE2 might increase inflation expectations, at least for a short time, which would be bearish for Treasuries all else equal.
• The immediate economic outlook, though far from rosy, might not be as dire as current yields imply; soft patch versus double dip is still unsettled.

Note that we have said nothing about “unsustainable deficits”, ”unsustainable debt to GDP ratios”, “debt monetization”, or actual inflation.  That’s because none of them are presently a true factor driving Treasury yields, in our view.  We still believe that structural factors such as household balance sheet deleveraging and shifting age structure argue for ten or more years of much lower real and nominal interest rates in the U.S. than most analysts, pundits, and investors are accustomed to.  Today’s discontinuity in inflation and interest rates is reminiscent of Japan’s from the early 1990s to today, and it is very likely to persist until at least the final years of this decade, if not longer.

Thus, while short term tactical bets on higher Treasury yields (falling Treasury prices) will sometimes work, over the longer term, we still strongly believe that the primary direction for longer term rates is down, as the yield curve continues to flatten while its short end remains anchored at very low nominal rates.  In fact, depending upon an investor’s circumstances and personal makeup, thirty years of “risk free” 3.6%+ coupons might still be an attractive investment!

On a related note, investing icons Jeremy Siegel and Jeremy Schwartz disagree with that last point in a recent WSJ op-ed, “The Great American Bond Bubble”.  Some of their observations are based on good old value investing techniques, but the main thrust of the editorial is (somewhat surprisingly) very weakly reasoned.  For example, there is absolutely no sound basis for comparing earning yields on tech stocks at the height of the Nasdaq to cash flow yields from Treasury securities.  Tech stocks were speculative, few paid any dividends, and the return of one’s initial investment capital was highly unlikely.  Coupon bearing Treasuries offer periodic cash flows and, if purchased at par, full return of nominal principal, guaranteed by the full faith and credit of the U.S. government.  The real puzzle is that Treasuries yielded 6% at certain points during the tech bubble, and have only slowly come down to their current levels.  Some of the investing world’s preeminent names are assessing the road ahead by looking in the rear view mirror. 

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Past performance is not indicative of future results. This material does not take into account your personal investment objectives, your personal financial situation and needs, or your personal tolerance for risk. Thus, any investment strategies or securities discussed may not be suitable for you. You should be aware of the real risk of loss that accompanies any investment strategy or security. It is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any particular strategy or investment. We do not guarantee any specific outcome or profit from any strategy or security discussed herein. The opinions expressed are based on information believed to be reliable, but SCM does not warrant its completeness or accuracy, and you should not be rely on it as such. Some clients of the firm own long term Treasury and Treasury Inflation Indexed securities, and some clients of the firm own shares of TLT.