December 19th, 2011

Shorting Treasuries: Conventional Wisdom Gone Awry

One of the perplexing aspects of the monetary and fiscal issues  around the world (especially here in the US) has been the absence of inflation and the strength of the $US.  In “Short TLT Rather Than Be Long TBT” (January 2010), I quoted from the NY Times:

“Liquidating investments that pay almost nothing in order to shift to long-term bonds that pay substantially more may not make sense right now, said Robert F. Auwaerter, the head of fixed-income investing at the Vanguard Group….interest rates — at both the short and the long ends of the yield curve — are likely to rise this year if the economy keeps expanding…..When bond yields rise, their prices fall. The effect is magnified for longer-term securities, so a 30-year Treasury bond would fall in value much more sharply than, say, a six-month Treasury bill.”

That was the conventional wisdom and has continued to be for some time.  To take advantage of what seemed patently obvious, one could play the rise in Treasury bond yields by either buying TBT, the ultrashort ETF or shorting TLT, the ultralong ETF.

But this was just another case of conventional wisdom goes awry.  The turmoil in Europe has caused money there to seek out a safe haven and,  as incredible as it is, that safe haven has been the $US and US Treasuries.  Rather than seeing yields rise as prices decline, rates continued to decline to historic lows.  Holding TBT in the expectation of rising rates has been an unmitigated disaster for all those holding TBT:

20-yr Treas Yields vs. TBT 2010-2011

Not only have yields declined rather than rising this year causing TBT to also decline but TBT has declined further on a relative basis (some of the difference is compensated by dividend distributions).  Holding TBT in the hopes of increases in yields due either to inflation or fears brought on by the budget disputes has resulted in a nearly a 50% loss.  If interest rates reverse and return from the current 2.5% to above 4.0%, the levels it was at the beginning of the year then TBT could be expected to nearly double.

It could be a long wait but perhaps at this point one that might be worthwhile.

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July 31st, 2008

The Final Shoe to Drop: Mortgage Resets and Interest Rates

I’ve been wondering why interest rates haven’t increased when evidence on all sides says they should:

  • we’re facing the prospect of significant inflation. Some say that the current inflation rate is in the area of 12-14% if they were recalculated on a basis consistent with the method used prior to 1998 (see Rating the Real Cost of Inflation).
  • The value of the $US has been consistently eroding
  • The budget deficit is unprecedented and continues growing. Without higher rates, foreign investors will stop funding this deficit at some point.

A Talking Head shed light on it yesterday (unbeknownst to them and surprising to me) when they made a comment that “mortgage foreclosures include fewer variable reset mortgages than originally anticipated because mortgagee’s can do so at affordable rates”. So that raised the question of what is going to be the flow of reset mortgages in the future and what, if any impact might that have on interest rates in the future.

I found the answer in a table prepared on a site called at the beginning of the sub-prime mortgage credit crises on August 13, 2007. The table, entitled Adjustable Rate Loan Resets For 2007–2008 follows:

Month           Millions
January-07      22
February-07     25
March-07        35
April-07        37
May-07          36
June-07         42
July-07         43
August-07       52
September-07    58
October-07      55
November-07     52
December-07     58
January-08      80
February-08     88
March-08        110
April-08        92
May-08          76
June-08         75
July-08         50
August-08       35
September-08    26
October-08      20
November-08     15
December-08     17

What that means to me is that the Fed and Treasury have been consciously keeping rates low until the balloon in variable mortgage resets (Jan-July, 2008)!

And what might we expect as the majority of these mortgages complete their resets and convert to fixed rates (assuming those funds are available), there will be less incentive to keep rates low. I can see that interest rates will start edging up beginning Labor Day and will accelerate significantly as we approach New Years.

If true, what does this mean to stock investors? I think that will be the final shoe in this economic recession cycle to fall and trigger the last drop in the index and stock prices.