A Bubble in U.S. Treasury Securities? Yes, and It's in "Extra Innings"

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Investors have been racing into U.S. Treasuries for percieved "safety" reasons. Time to tighten durations.

Care to lend Uncle Sam your money for 10 years at 1.66% interest? Well, inflation doesn't appear to be rearing its ugly head. The "fuel" commodities have been trending downward this year; metals (except copper and palladium) are up in line with the Dow Jones and other equity indexes (except Nasdaq 100, which is up double digits); and agricultural commodities are way off (except soybeans and lumber). In short, the drivers of inflation don't seem to be offering troubling signs, well, not just by looking at year-to-date price movements. (See the drop in the producer price index for May announced this morning for details.)

Despite the April/May correction-like swoon buffeting equities, do you really want to go long 10-year Treasuries? Here is what Doug Ramsey, a senior researh analyst at the Leuthold Group, has to say about the price of Treasuries:

"Yes, we consider U.S. Treasury Securities to a bubble across the entire yield spectrum, and the situation has probably now moved into 'extra innings' (10th or 11th) thanks to the flight to (perceived) quality triggered by the European debt crisis. But Bernanke's arm is getting sore, and ace closer Timothy Geithner has wanted off the team for more than a year.

"I'm becoming more convinced this extra inning thriller is nearing an end. My conclusion is based partly on our bond market analysis, and partly on the ever-escalating, self-assurance of bond managers that I know wither personally or via Bubblevision. They're all puffed up, razing already spectacular homes to put up even bigger ones and slapping one another on the back for having foreseen the 31-year slide in interest rates. They pontificate --- cigars in hand --- over the "lost decades," and marvel at the bullet-proof logic underlying Liability Driven Investing (LDI). I feel more out of place around these new masters of the universe than when I was sent (by the Value manager I was working for) to the then-legendary Montgomery Growth Conference at the San Francisco Ritz-Carlton in the fall of 1999.

  • "In my opinion, spectators looking to 'play' the last half inning or so of the great bond bubble (from either the long or short side) should supplement, if not replace, their fundamental analyses with tools focused on technical market action and Treasury market sentiment. These tools offered the only sane way to play the final phase of the tech/telecom insanity in 1999 and 2000. Investors, thouh, should probably just stand aside, own a fair amount of low duration 'spread product,' and watch the Treasury train wreck unfold from a safe distance."

[Emphasis original.]

Like many others that I speak to, I believe inflation is in the mail, so to speak. How can you print money and keep interest rates at near zero and NOT suffer, eventually, nasty inflation? According to Ramsey, stocks (the S&P 500) jumped by 26% in fiat currency terms (as Ramsey puts it) but remained flat versus gold (or, as Ramsey calls the latter, "a nice, hard currency that's been around a while longer").

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