In a recent letter, Scott Minerd of Guggenheim Partners argues that thanks to the world’s central banks, the economy — at least in the US — has entered a self-sustaining recovery, and that domestic investments will continue to do well.
And like many other top tier investors (too many to count, really) he loathes Treasuries.
In the U.S. fixed income markets, the credit trade has worked very well. As concerns about the recession dissipate, riskier asset classes are rallying. However, while below investment- grade credits continue to look attractive, Treasury yields remain unsustainably low. I think the Fed’s policy actions will keep rates lower than they normally would be, but I believe the improving U.S. economy will put upward pressure on rates over the next six to twelve months. Essentially, what we have right now in the Treasury market is a Ponzi scheme. If the market had its way, Treasury rates would be at least 100 basis points higher than they are today. But because there is a buyer out there who is willing to keep purchasing these securities, even though it doesn’t make any economic sense as a prudent investment, the market has reached levels that wouldn’t be sustainable if free market forces were allowed to prevail.
Photo: Guggenheim Partners
The bottom line is Treasuries at current levels are exceptionally overvalued. As the U.S. economy continues to heat up, I think we will likely see a negative total return for Treasury securities this year. To put that in perspective, Treasuries have gone negative only three times in the past 38 years: 1994, 1999 and 2009. It doesn’t happen very often, but given the low current yield, the likelihood for price depreciation is high. It is time to short long-dated Treasury securities, something many of my colleagues in the fixed-income world are loathe to recommend given the huge losses taken over the past 12 months by those who failed to recognise the determination and ability of the Fed to lower the term structure of interest rates.