U.S. Treasuries: A Return-Free Investment?

A recent Bloomberg story called it “the biggest sell-off in Treasuries since 2010.”

That’s how the story characterized the recent and rapid backup in U.S. Treasury bond interest rates. In fact, yields on the benchmark 10-year U.S. Treasury rose above 1.86 percent last week, up from a record low of just 1.38 percent as recently as July 25.

So is the historic bond bubble about to burst at long last?

Perhaps. After all, U.S. Treasury bonds have been in very high demand since the global credit crunch sent investors scurrying for the perceived, relative safety of government bonds. This so-called flight-to-quality trade has relentlessly pushed yields lower.

Since that time however, the U.S. government’s fiscal picture has steadily deteriorated — along with those of Europe and Japan — making investors wonder if interest rates at such low levels are adequate compensation for making a ten-year loan to Uncle Sam!

Rather than being the “risk-free investment” they expected … investors in U.S. Treasuries now could wind up with a “return-free investment” over the long run.

Click the chart for a larger version.

In fact, a glance at the recent outsized returns for bonds shows you just how much this may be a bubble of historic dimensions. Like tech stocks in 2000 or real estate in 2006, bonds have enjoyed a multi-year run of outperformance …

* Since 2010, long-term Treasury bonds have posted a total return of more than 50 percent, a remarkable figure reminiscent of the heady days of Nasdaq gains in the late 1990’s … or single family home prices circa 2005.

Most of this return has come from capital appreciation as yields plunged to all-time record lows.

* After subtracting the current inflation rate of about 2 percent, investors get a negative real-yield from owning 10-Year Treasuries. In other words, you’d be PAYING Uncle Sam for the privilege of parking your money at the U.S. Treasury over the next decade!

Oh, and calculating the after-tax return makes matters even worse.

* Recently, even the “Bond King” himself, Bill Gross, the world’s largest bond fund manager warned: “Risk averse investors looking to hide in Treasurys will see a haircut relative to future inflation.”

That’s putting it mildly … a scalping is probably more like it!

So When Will This
Bond Bubble Finally Burst?

The precise timing is anyone’s guess. Indeed, we’ve witnessed temporary bond market sell-offs before, with interest rates always sinking lower eventually.

But you can bet your bottom dollar at some point soon — probably when most investors are not expecting it — interest rates and inflation will begin moving higher in a lasting upswing. When that happens, it’s likely to be a swift and profitable move for investors positioned on the right side of this historic interest rate shift.

An easy and low-cost way to consider positioning yourself now — ahead of the bursting bond bubble — is with exchange traded funds and exchange traded notes.

The ProShares Short 20+ Year Treasury (TBF) is one way to play it.

This inverse ETF aims for the opposite performance of the Barclays U.S. 20+ Year Treasury Bond Index. As bonds decline in price (yields rise) this ETF should appreciate in value. It’s an extremely liquid ETF trading nearly one million shares per day making it a good choice to hedge against the probability of higher rates.

And to specifically target the benchmark 10-Year U.S. Treasury note on the down side, you might consider the iPath U.S. Treasury 10-year Bear ETN (DTYS).

Typical daily moves in the bond market can seem small, expressed in basis-points (just 1/100th of a percent). So for investors interested in taking maximum advantage of smaller interest rate swings, or over a shorter time frame, there are leveraged inverse ETFs that can give you more bang for your buck if you’re correct about the bond market’s direction.

The Direxion 7-10 Year Treasury Bear 3X (TYO) is a fund designed to give you three times the inverse daily performance of the NYSE 7-10 Year Treasury Bond Index. In other words, if Treasuries decline 1 percent, TYO should rise 3 percent in value.

Whether the great American bond bubble keeps on rolling along, or is already losing hot-air, it pays to remember that with yields at such historic lows investing in Treasuries is far from risk-free.

Good investing,

Mike Burnick

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.