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Manage Subscription MONDAY, JANUARY 5, 2009 BARRON'S COVER Get Out Now! By ANDREW BARY The bubble in Treasuries looks ready to pop, sending prices on government debt sharply lower. But just about every other corner of the bond market beckons -- and could provide competitive returns with stocks, even if the equity markets have a strong 2009.
Bloglines Reader Or copy the rss link: THE BIGGEST INVESTMENT BUBBLE TODAY may involve one of the safest asset classes: US Treasuries. Yields have plunged to some of the lowest levels since the 1940s as investors, fearful of a sustained global economic downturn and potential deflation, have rushed to purchase government-issued debt.
Getty Images The market also has been supported by comments from the Federal Reserve that it, too, may buy long-term Treasuries. The 30-year T-bond stands at 282%, and three-month Treasury bills were sold last week for a yield of just 005%. While a holder can expect to get repaid in full at maturity, the price of longer-term Treasuries could fall sharply in the interim if yields rise. The 30-year T-bond, for instance, would drop 25% in price if its yield rose to 435%, where it stood as recently as Nov. The bear market may have begun Wednesday, when prices of 30-year Treasuries fell 3%.
Yields on 30-year Treasuries easily could top 4% by year end. The chief risk to the Treasury market stems from the potentially inflationary impact of both the Federal Reserve's super-accommodative monetary policy, which has dropped short rates close to zero, and the enormous looming fiscal stimulus from the federal government. It also may take higher yields to attract investors -- particularly foreigners -- as the Treasury seeks to fund an estimated deficit of $1 trillion or more in the coming year. ONE SIGN OF TROUBLE FOR TREASURIES is the resilient price of gold, which has risen $150 an ounce since late October, to $880 an ounce, despite weakness in most commodity prices. Investors rightly see gold as an appealing alternative to low-yielding Treasuries and virtually nonexistent yields on short-term debt as the government cranks up its printing presses. Gold was up $45 an ounce last year, while oil was down 50%. Another worrisome indicator: The dollar has weakened recently, losing 10% of its value against the euro in the past month.
Ultrashort Lehman 7-10 Year Treasury Proshares (PST), offer a bearish bet on the Treasury market. Both these securities are designed to move at twice the inverse of the daily price movement in Treasury notes and bonds. Since the summer, the 20+Year Proshares has fallen almost 50% as Treasury prices have surged. If Treasury yields return to June levels, the ETF could double in price.
iShares Barclays 20+Year Treasury Bond Fund (TLT), an ETF that gives exposure to the long-term government-bond market. While Treasuries look rich, other parts of the bond market beckon, including municipals, corporate bonds, convertible securities, some mortgage securities and preferred stock. The average junk bond now yields 20%, compared with 9% at the start of 2008. Triple-A-rated munis with 30-year maturities are yielding about 525%, almost double the yield on 30-year Treasuries. The yield differential between the two markets is unprecedented. Until this year, munis almost always yielded less than Treasuries because of their tax benefits. Long-term corporate bonds with investment-grade ratings of triple-B now yield an average of 8%, nearly 55 percentage points more than Treasuries of comparable maturity. They rarely have yielded more than four points above government debt.
Bank of America (BAC) and Morgan Stanley (MS) yields 9% or more, and many preferreds carry tax advantages because their dividends, like those on common shares, are subject to a 15% federal tax rather than rates on ordinary income. "The only part of the bond market that you need to be bearish on is Treasuries," says Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. A bearish stance toward Treasuries and a bullish one toward the rest of the bond market represents the consensus view.
At the same time, it's hard to find bears on corporate bonds. Lately corporate and municipal bonds have rallied, with Merrill Lynch's junk-bond index gaining more than 6% in December, the strongest monthly increase since 1991. Most yield disparities between corporate and municipal bonds and Treasuries still are off the charts relative to historical ranges. Perhaps more important, absolute yields on corporate and municipal debt look attractive relative to inflation, and even stocks. It's tough to estimate the current price/earnings ratio on the Standard & Poor's 500 stock index because the profit outlook is so uncertain amid a recession. Assume $60 in S&P earnings for 2009 and the index, now about 925, trades for 15 times forward profits, not cheap by historical standards. Equity bulls are betting the $60 estimate proves conservative, and that corporate earnings grow sharply in 2010. The S&P likely earned about $72 in 2008, before massive write-offs. The smart money is crowding into the corporate-bond market, including investment-grade debt, junk bonds and so-called leveraged loans, which are bank loans to debt-laden companies such as Neiman Marcus, Georgia-Pacific and First Data. Leveraged loans, which are senior to junk bonds, now trade for an average of about 70 cents on the dollar and carry yield to maturities of 10% to 15%. Many equity-oriented hedge funds and mutual funds have added to their corporate-bond holdings because of enticing yields.
"The argument is that the credit markets have to straighten themselves out before stocks rebound," says Marty Fridson, who heads Fridson Investment Advisors in New York. "Investors will rotate into the credit markets and then into stocks when they look more promising." Some investors argue the credit markets are discounting a grimmer economic and financial outlook than the stock market, and thus more opportunity lies in bonds. Junk-bond default rates, which ran at just 34% in the past 12 months, are certain to spike in 2009. Moody's Investors Service expects the US junk-default rate to top 10% in the next year. Yet, with a 20% average yield, junk bonds could provide nice returns, even in that scenario. "You're buying the market at a pretty steep discount," Fridson says. "You're getting compensated for a severe escalation in defaults." The average junk issue trades for less than 60 cents on the dollar, and some bonds, like those issued by the bankrupt Tribune, have sunk to just pennies on the dollar. Defaults might have to run at a cumulative 50% rate in the next five years and recovery rates average just 30 cents on the dollar -- versus a historical average of about 40 cents -- for investors to get sub-par returns. The junk market declined about 27% in 2008, by far the worst showing in the past 20 years. If history is any guide, 2009 should be better because down years like 1990 often have been followed by big gains. It wouldn't take a lot for junk to return 20% in 2009, given the elevated yields throughout the market.
Loomis Sayles Bond fund (LSBRX), which owns a mix of US and foreign government bonds, investment-grade corporates and junk debt, fell 22% last year. The fund, co-managed by bond veteran Dan Fuss, now has a current yield of around 11%. Convertible securities, which were bashed in 2008 in part from forced selling by leveraged hedge funds, offer a nice combination of yield and equity kickers.
Ford Motor 's 425% convertible bond due in 2036, trading for about 27 cents on the dollar for a 27% yield to an optional redemption date in 2016, is a good alternative to the common stock , which yields nothing. Vanguard, Fidelity and Putnam all have open-end convertible mutual funds, and there are many closed-end funds, including some trading at discounts to their net asset values. The backdrop for municipal bonds is troubled because state and local governments are getting squeezed by lower tax revenue and sizable outlays for basic services and other needs. Investors are getting compensation via 5% to 6% yields on top-grade long-term securities and hig...
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