No Taper Is A Gift: Sell All Long-Term Bonds Now
Sep 18 2013, 21:44
The exact starting point and pace of tapering does not matter very much at all. As long as you believe that QE will end at any time within the next three years, the 10Y Treasury Note and virtually all long-term bonds are severely overvalued and constitute bad investments.
Normalization Of Long-Term Yield Is InevitableBy definition, the end of QE implies economic normalization. Economic normalization implies annualized real GDP growth of 2.5%-3.0% and CPI of 2.0%-3.0%. In turn, this implies 10Y US Treasury yields in the range of 4.5%-5.5% based on historic norms.
There is every reason to believe that 10Y yields will reach or surpass this normal range for 10Y yields when the Fed ends QE. First, it is important to note that the current 10Y yield of 2.69% is a product of extreme levels of intervention by the Fed; the Fed has purchased and now holds 49% of all US Treasury bonds outstanding with a maturity of 10-15 years. This extreme level of Fed manipulation has had a major impact on long-term yields, and ending the manipulation can be expected to have an equal and opposite effect. Second, by the time economic conditions normalize, the risks of owning US Treasuries will be higher than ever. At that particular point in time, the deterioration of long-term US fiscal fundamentals and the risks associated with them will be at all-time highs.
Furthermore, at that particular point in time, the historically unprecedented level of excess liquidity in the economy combined with a normalized level of risk aversion and liquidity preference (associated with a normal economic growth rates) suggest that inflationary risks will be at extraordinarily high levels.
A 10Y Treasury note yielding 4.5%-5.5% any time in the next three years implies a capital loss in the order of 12%-20%+ for holders of those bonds. The yield differential between the 10Y which is currently yielding 2.69% and safe short-term alternatives yielding 0.5%-1.0% simply do not compensate the prospective capital loss and/or the opportunity cost of holding 10Y Treasury notes - even if you assume interest rate normalization will take another three years.
The Fed has warned you: QE is coming to an end. It may not happen in mid-2014 as originally targeted by the Fed. But QE will come to an end one way or another - most likely within the next 1-2 years. It will come to an end either because of a normalization of economic growth and employment conditions (optimistic case) or because the unprecedented levels of excess liquidity in the economy and their related distortions in asset and/or product markets force the Fed to end QE "prematurely" (pessimistic case).
Take Action Now: Sell Bonds Into Strength
Traders and hedgers have been caught wrong-footed by the Fed's taper surprise. As a result, bonds should experience a brief rally based on short covering. However, this rally is likely to be very short-lived as longer-term bondholders are aware that the math is working against them. Many large bondholders are going to be selling heavily into this short-covering rally, so the rally is unlikely to go very far or for very long.
So what are you waiting for? Don't look a gift horse in the mouth. The market is providing you with what may be your last opportunity to get rid of fixed income duration in your portfolio.
Investors should take advantage of the sharp rally to sell out of all long-term duration in their portfolios. Sell long-term government and corporate bonds, long-term bond funds. Sell all ETFs such as TLT, IEF, AGG, JNK and HYG.
Long-term implications for equity indices such as the S&P 500 and index ETFs such as SPY are more ambiguous. Stocks never truly priced in treasury yields at their lows. Therefore, it is not clear that movements in long-term interest rates will have a significant effect on equities as a whole. However, dividend sensitive sectors such as REITs, mREITs and utilities may be more affected.
0 comments:
Publicar un comentario