BUYING THE 10 YEAR AT 1.66%: THE NEVER ENDING SEARCH FOR THE GREATER FOOL

4/29/13

Holly Liss, ABN AMRO Clearing’s director of Global Futures was on Bloomberg Radio just a few minutes ago talking about the upside potential of the 10 year treasury.   Ms. Liss is one of the brighter traders out there, or at least one of the brighter traders who appears on the financial media, so I generally try to listen when she speaks.

Ms. Liss likes the 10 year treasury, which currently yields 1.66%.   While she says that she can’t see the 10 year trading to a 1.00% (Gulp!) yield, as some bond bulls are arguing, she said she could easily make the case for a 10 year yield in the 1.30% to 1.40% range.   Her argument is straightforward:   the economy remains slow, Fed quantitative easing (“QE”) action will continue and will be skewed heavily toward the long end of the curve, a skew that will be exacerbated by the continuation of Operation Twist.   As regular readers know, I don’t feel equipped to make short term calls on any market (See my two 4/15/13 posts, GOLD:  YES, I’M SCARED…BUT I’M STAYING and SO WHY HAS THE STOCK MARKET DONE SO WELL OF LATE?) and suspect that most people have a similar shortcoming, including, perhaps especially, those who claim the degree of acumen necessary to make such trading calls.  Nonetheless, it’s hard to argue with Ms. Liss’s logic, especially when she was careful to argue that she is not advising anyone to buy a 1.66% ten year and hold it to maturity; she is advising only a trade at 1.66%.   If she is right and the 10 year does trade to the 1.30% to 1.40% range, this trade will, of course, prove to have been very lucrative.

But think about this for a moment….

Again, Ms. Liss is not advising buying the 10 year at 1.66% and holding it to maturity.  Very few people with even a reasonably firm hold on their senses would advise such a strategy; if earning 1.66% for 10 years turns out to be a good, or even a not all that disastrous, exercise in positioning, we have a lot more to worry about than the conditions of our treasury portfolios.  

But by buying even for a trade, one is making the implicit assumption either that one is buying value for the long run or that a greater fool will come around quickly enough to relieve one of what appears to be a very malodorous long run investment.   In other words, if we buy the ten year (or any instrument, for that matter) despite not liking it for the long run, we are betting that someone, the greater fool, must believe that the 10 year is a good buy at a yield presumably even lower than 1.66%...or that the fool in turn can find an even greater fool to take him out of his position at an even more absurdly low yield.

This is a dangerous game of musical chairs.   I will let others who are confident of their ability to move quickly when the music stops play this game.   As a long term investor, I want no part of either aspiring to a miserably low yield for 10 years or betting that I can find someone with even more misplaced trading hubris to take me out of what I know, and presumably everybody knows, is a rotten long term position.   I’ll leave that to the clever people.

S&P YIELDS VS. BOND YIELDS: I’M YOUR MAN WHEN IT COMES TO STATING THE OBVIOUS

4/16/13

A guest on CNBC this afternoon (I didn’t catch his name; the sound is normally turned off on CNBC and I only turn it on when something interesting, or someone I really want to hear, like Art Cashin, Jack Bogle, or (sometimes) Rick Santelli comes on.  But the guest’s name is not as important as his argument.) was making the bullish case for stocks.   He pointed out that stocks were “under owned,” that the percentage of the public owning stocks is normally 30% but is now 18%.   (Don’t hold me to those numbers; they are the guests and I didn’t verify them.)  He also pointed out that people face lousy potential yields on their bonds and cash and thus will consider stocks, where (paraphrasing)

…half the S&P stocks yield more than 2.5%, which is about what people can get on the proceeds from their maturing bonds, and YOU HAVE THE POTENTIAL FOR GROWTH.  (Emphasis mine)

(See my post from yesterday, SO WHY HAS THE STOCK MARKET DONE SO WELL OF LATE? for a discussion of this argument.)

This is not a bad technical argument for stocks, though the host denied being a technician.  Despite the validity of the argument, though, maybe it’s time for someone to state the obvious for two reasons

1. In general, a firm grasp of the obvious seems to be out of the reach of the more sophisticated types, and
2. this particular jot and tittle of the obvious seems to be escaping people of late.

So here goes…

Yes, the S&P is yielding considerably more (about 30 basis points (“bps”)) than the 10 year treasury and, yes, the S&P has potential for growth.  But stocks also have the potential for shrinkage, and sometimes great shrinkage.  This potential for loss on stocks is far greater than the potential for loss on the 10 year treasury, even at these low bond yields.   And, unlike the prevailing situation with a treasury, there is no assurance (Emphasis mine; see yesterday’s post on stocks again.) that the principal invested in stocks will be returned. 

This is certainly not an argument that bonds are at all attractive; see my 2/26/13 post CZAR BERNANKE’S DIKTAT:   BONDS MUST BE RICH, STOCKS MUST BE CHEAP in which I opined

But, with a Fed engineered bubble to end all bubbles in the bond market, EVERYTHING is cheap relative to bonds.  

This is also not an argument that stocks are necessarily rich; I am simply reiterating a point I made in that 2/26 post

That they (stocks) are cheap relative to a hideously inflated bond market is no reason to buy stocks.

But I also argued for stocks, sort of, in yesterday’s post.  

My important point regarding stocks is that no one knows where stocks are going in any run but the long run and anyone who tells you s/he knows where stocks are going hasn’t been around long enough, or been sufficiently humbled by his or her hubris, to be entrusted with your money.   But I digress, sort of.

My overriding point in this post is not to argue for the cheapness or richness of stocks, or even to reinforce my argument that bonds are insanely rich.   Rather, I am arguing that the “stocks yield more than bonds” argument for buying stocks is dangerously simplistic, especially now in the midst of a bond bubble, and, if followed to its logical conclusion, should bring us to a bad end.