Treasuries Continue to Deliver Gains

Well that didn’t last long. After three straight weeks of sliding, the S&P500 roared back last week and registered a 2.6% gain. Volume was moderate and volatility, as one would expect in an up week, slipped back down to very complacent levels.

Was there a rash of good economic news that pushed the equity markets higher? On the contrary, the news from Main Street was almost all bad. The Empire State manufacturing survey missed. Industrial production missed badly. The housing market index also missed. Housing starts were atrocious, and logged their worst miss vs. expectations since early 2007.  The current account was worse than expected; this will hurt the 1st quarter GDP results. The Philly Fed outlook missed expectations, and so did leading indicators. Only initial jobless claims beat expectations, and even so, by the thinnest of margins.

So what caused stocks to jump?  Perversely, the in the Fed’s meeting announcement, the Fed noted that the US economy is slowing down. This bad news (which we’ve been noting here for the last several months) suggested that the Fed would not be able to raise rates (in other words, tighten monetary policy) for longer than the markets were preparing, and this was perceived to be good for stock markets. So to summarize, bad news on Main Street means good news for Wall Street.

This has been a theme equity investors have picked up on for the last several years. In fact, it explains most of the stock market exuberance during this time—the thinking has been that as long as the Fed is worried, then one must buy stocks and never….ever….worry about valuations because they simple cannot go down—meaningfully—when the Fed is so accommodating. In other words, the stock market party is not over.

Outside of equities, we’ve been chronicling the opportunities in being long US Treasuries since late 2013. And when the yield on the US 10 year touched 1.65% in late January 2015, we noted that it was no longer a good value. Since then, the yield—unsurprisingly—rose. In fact, it jumped all the way up to 2.25% in mid March. At that time and at that yield, it became a much better value.

Over the last week or so, also unsurprisingly, the yield on the 10 year dropped back down to almost 1.9%. So anyone who bought in the 2.2% range has made a huge profit over this short period of time, and more importantly, this profit came with a far lower risk than it would have in high yield or stocks. So on a risk-adjusted basis, this gain is even more impressive.

The bottom line in US Treasuries is that the yield downturn that resumed in 2013 is not over. And until this trend is over, the correct strategy is to buy US Treasuries on big dips in prices.

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