US Treasuries on Sale?

Nothing, it seems, can stop the Fed’s QE2 from pumping up the S&P500.  Despite a near revolution in Egypt and a whole host of other domestic and international pressures,  the S&P rose 2.7%, but on lower volume, meaning that the investor conviction was lacking.  The VIX retreated, also as expected, if investors keep believing that the Fed’s “put” will make a meaningful drop in stock prices impossible. 

The economic data were mixed.  Personal income (boosted by the government’s transfer programs) met expectations; personal spending rose more than expected, implying that personal savings rates fell.  The ISM manufacturing index was stronger than predicted. Construction spending fell when it was expected to rise.  Initial jobless claims were about as expected–stubbornly stuck in the 400,000 range that’s associated with recessions.  The ISM services index was stronger than expected.  The big number of the week was payrolls, and it was a big miss, coming in over a 100,000 below expectations.  While the headline unemployment rate dropped, all of the apparent improvement came as a result of folks giving up on looking for jobs.  To back that up, the labor force participation rate (the % of folks between 16 and 64 who are working or looking for a job) fell to 64.2%, the lowest since 1984.  Also, the straightforward percentage of the US population that’s employed fell to 57.6%.  Both of these rates point to a grim and deteriorating employment situation.  More and more people are simply giving up–because job opportunities are so poor–and leaving the ranks of the UNemployed.  That’s the reason the unemployment rate fell, and it points to more economic problems ahead.

Technically, the S&P500 hass all the markings of  market that’s not behaving naturally.  Retail investors have pulled about $100 billion out of the stock markets over the last year; mutual funds have run out of spare cash to invest.  Yet the markets melt up. Why?  Because the Fed prints dollars out of thin air and openly promotes the virtues of artificially stimulating the stock market. Nevermind the total failure to create jobs.  The Fed pumps the money into the markets, daily, in the late mornings.  On many mornings the stock markets sell off in the first two hours, but in almost every case, the “recover” by late morning and early afternoon–right after the Fed’s securities buying ends.   What happens when the Fed stops QE in a couple of months?  How can the end of QE possibly end well?

So we’re in a time where most risky assets are fully valued or over valued.  Almost everything you can buy for investment is not cheap:  stocks, investment grade bonds, high yield bonds, commodities, international equities and many other asset classes are priced near the high-end of their long-term ranges.

But is anything cheap?  What’s priced relatively well, providing an investor with a better margin of safety? 

A few weeks ago, we discussed municipal bonds.  They’re one asset class that’s in a correcting phase.  But they’re not ready to be bought.  Prices are still falling and many of the fundamental reasons sparking the original sell-off have not yet been resolved.

But interestingly, there’s one asset class that’s been crushed over the last three months, and may be much closer to price levels that could be bought more safely. 

US Treasuries have suddenly become cheap.  The 10 year yielded as little as 2.33% in October.  Today, it offers 3.62%.  In the Treasury world, that’s a massive sell-off.

Also, it’s interesting to note what happened to Treasury prices the last time the Fed’s QE program wound down.  Back in April 2010, when QE1 officially ended, the 10 year Treasury began monster move up in prices (down in yield) that lasted six months. 

The Fed’s current QE program is scheduled to wind down in a couple of months–after a huge price reduction in Treasuries has already begun. 

If Treasury prices stop falling over the next 60 days, and risk assets start selling off (as QE2 winds down), then a repeat of the 2010 sequence would make a lot of sense, as investors rushed into a deep, liquid and relatively safe harbor to park cash for a few months. 

The middle of the yield curve could prove to be especially attractive, as the spreads over the two year Treasuries near (or even exceed) record highs.  And 5 -10 year Treasuries will also offer somewhat attractive yields (that, unlike stock dividends, accrue daily)  to pay you while you wait for prices to rise.

Don’t buy Treasuries yet.  And certainly don’t buy Treasuries as a long-term investment (the government’s fiscal mess is getting worse every year).  But consider them as a potential contrarian play that a lot of big money could rush into once QE2 starts to peter out.

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