By Daniel Kruger
Dec. 22 (Bloomberg) -- The world’s biggest bond investors can’t stop buying Treasuries even though they’re comparing government debt to Internet stocks just before the technology bubble burst.
The worst economy since World War II, credit-market losses exceeding $1 trillion and the biggest drop in the Standard & Poor’s 500 Index since 1931 are luring investors to U.S. debt just as the government prepares to sell a record amount to pay for the swelling budget deficit. Investors loaned money to the Treasury at zero percent interest this month to safeguard their principal from wider losses.
“I’d like to think that what I am doing is taking a pragmatic approach,” said Wan-Chong Kung, a money manager who helps oversee $76 billion in fixed-income assets at FAF Advisors in Minneapolis. “It sounds like quite the chicken thing to do, but right now being brave seems too darn close to being perilous,” said Kung, whose First American Intermediate Government Bond fund gained 9.6 percent this year.
The Treasury sold $30 billion of four-week bills on Dec. 9 at a rate of zero percent, the same day three-month bill rates turned negative for the first time since the U.S. began selling the debt in 1929. Yields on 2-, 10- and 30-year securities are below 3 percent. As recently as June the so-called long bond yielded 4.81 percent.
The drop in yields pushed returns on Treasuries to 10 percent since October, led by a 37.5 percent gain in 30-year bonds, according to Merrill Lynch & Co. index data. Only twice this decade have annual returns surpassed 10 percent: 13.4 percent in 2000 and 11.6 percent in 2002.
‘The Illusion’
Treasuries outperformed the Standard & Poor’s 500 Index by 55 percentage points this year, the biggest margin since at least 1978, when Merrill Lynch started calculating the returns.
Government plans to sell $2 trillion of debt, as predicted by New York-based Goldman Sachs Group Inc., are setting investors up for losses, said James Grant, editor and founder of the financial journal Grant’s Interest Rate Observer.
“What it speaks to is the illusion that some securities are inherently safe or inherently valuable,” Grant said during an interview in New York on Dec. 17. “People are piling into Treasuries now, as if they were, they’re like a Cisco Systems in 1999. I don’t know what they’re priced for, but they’re not priced for life as I know it in this economy.”
San Jose, California-based Cisco Systems Inc., the biggest maker of computer networking equipment, traded at $80, or about 193 times earnings in March 2000 after gaining 130 percent in 1999 and 150 percent in 1998. Now, the stock is at $16.64, or about 12 times earnings.
‘Credit Collapse’
The 30-year bond fell for the first time in seven days on Dec. 19, pushing yields up four basis points, or 0.04 percentage point, to 2.55 percent, according to BGCantor Market Data. The 4.5 percent security due in May 2038 dropped 1 1/32, or $10.31 per $1,000 face amount, to 140 2/32. For the week, the long bond rose 11 30/32, or $119.38, sending the yield down 0.49 percentage point.
While demand for Treasuries resembles the excess seen in technology stocks in 2000 and real estate six years later, yields may still decline and stay near record lows as the Federal Reserve, households and institutional investors increase purchases as the economy worsens, said David Rosenberg, chief North American economist at Merrill Lynch in New York.
“This is what happens evidently after a credit collapse,” Rosenberg said in a Bloomberg Television interview on Dec. 17. President-elect Barack Obama’s planned fiscal stimulus “at best will help stabilize the situation, but it won’t prevent the recession from taking its course,” he said.
Rosenberg’s Prediction
The Fed cut its target interest rate for overnight loans between banks to near zero percent on Dec. 16 from 1 percent, and said it may buy debt to lower borrowing costs. Obama, who will inherit an economy that lost 1.9 million jobs in 2008 through November, said he plans to spend about $850 billion over two years to jump-start the economy.
Financial companies reported $1 trillion in losses and writedowns from distressed assets, according to data compiled by Bloomberg, while the government on Dec. 19 agreed to provide Detroit-based automakers General Motors Corp. and Chrysler LLC with $13.4 billion in loans.
Rosenberg, who in January correctly said the economy had already entered its first recession since 2001, expects gross domestic product to contract 2.5 percent in 2009. The median estimate of 78 contributors in a Bloomberg survey is for a drop of 0.9 percent.
‘More Room’
“There’s probably a little more room for the Treasury market to run,” said Thomas Girard, a money manager who helps oversee $110 billion in fixed-income assets at New York Life Investment Management in New York. “We’ve been very, very gently trying to add some non-Treasury-related holdings into the portfolio, but that’s been a very slow process simply because of the powerful rally in Treasuries.”
Girard shifted some of his holdings out of shorter-term securities into 10-year notes on the expectation that yields on longer-term debt can still decline. Ten-year notes yield 1.38 percentage points more than two-year notes, compared with an average of 0.97 percentage point since 1990.
“There’s certainly been a lot of momentum in the Treasury market and it hasn’t felt like it’s time to get out,” said Scot Johnson, a money manager in Houston at AIM Investments, which manages about $4 billion in fixed-income assets.
‘A Bargain’
Johnson’s AIM Limited Maturity Treasury Fund, which focuses on shorter-maturity debt, returned 5.6 percent this year. He’s buying Treasuries with cash that flowed into the fund even as yields “blew through” his targets.
“Whenever we approach the most recent target we’d set, it seemed like some piece of bad news would come out that would force you to admit that perhaps Treasury yields were headed even further lower,” Johnson said.
Van Hoisington, president of Hoisington Management, which oversees $4.5 billion, say there is no bubble and that long-term Treasury yields have room to fall. His long-term bond fund, The Wasatch-Hoisington U.S. Treasury Fund, returned 41 percent this year, beating 96 percent of its peers.
Hoisington forecasts that the economy won’t grow in 2010, when adjusted for inflation, and that the consumer price index will fall, which suggests “you can argue the ultimate objective of the 30-year bond is 2 percent,” he said.
At a yield of 2.56 percent, a rally to 2 percent in the next 12 months would produce a 13 percent return.
“If you accept the fact the economy’s going to be slow- growing for the next three or four years and inflation in fact is going to zero then it would be a bargain,” Hoisington said.
To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net
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