Added June 6, 2009: A recent article about the tracking error problems of TBT, the ultrashort ETF for the 20 year treasury can be found at SeekingAlpha
The author of that article suggests that TBT should not be used except for daily trades. For my purpose, using TBT as a hedge for my long term corporate bond portfolio, I will look at using TBT for months at a time, not for years due to the tracking issue. I do recognize that there is frequently a serious tracking error with these double shorts that can become substantial over long periods: Market
As of June 6,2009, I have taken profits on both PST and TBT.
**********original post
1. Australia GDP RISES & AUSSIE DOLLAR STRENGTH: The Australian GDP rose .4% in the first quarter of 2009 and was expected to decline .2% Australia Since I own Australian dollars, I try to keep track about what the Australian Central Bank is doing. The Reserve Bank held rates steady at a 49 year low of 3%, stating it did not see any reason to cut rates again. UPDATE This is relevant to my ownership of FXA since my monthly interest rate is tied to what the Australian currency earns from a demand rate for Australian dollars minus expenses. Currency ETF
The dividends have fallen a great deal over the past year due to the decline in the demand deposit rates in Australia, which is typical for most developed countries due to the worldwide economic downturn. Generally, however, I would be expected to be paid more interest tied to the Aussie demand rate than one based on U.S. rates. I have already realized significant profits trading FXA, and my current position is down to just 30 shares, sort of a core minimum position.
This is a link to a 3 month chart in FXA showing the bull move starting on March 9, 2009 at $63.3 and ending at $82.19 yesterday.
2. Spread between 2 and 10 Year Treasury Hits a Record: This is a link to the U.S. Treasury Departments daily treasury yield curve rates: U.S. Treasury - Daily Treasury Yield Curve
The 2 year is at .96% and the 10 year is at 3.65% as of 6/2/2009. Bloomberg reported on 5/27 that the spread between the 2 and 10 year treasury had widened to 2.75% which was a new record for that spread. Bloomberg Some believe that a steepening yield curve may indicate a market expectation of higher inflation beyond the 2 year maturity, while others would maintain that the increased spread simply signals an economic recovery. My two cents is with both sides. Brief
3. Break-even rate for the 10 year TIPs/ Pricing of the TIP and Comparable Non-Inflation Protected Securities: Investors in the TIP need to be aware of how the market is pricing the TIP compared with a similar maturity non-inflation protected treasury security. The break-even point has now risen over 2% again for the first time since September of last year.WSJ.com WSJ.com That means that the TIP is pricing in more inflation risk, and the difference in yields between the two securities have widened. Just think of it this way.
This is a link to the WSJ page on the pricing of treasury inflation protected securities: WSJ.com
It was not that long ago that there was a miniscule break-even point. Comments on Barron's Roundtable; TREASURY INFLATION PROTECTED BONDS (TIP)
This raises a number of logical questions. Is the spread subject to mood swings rather than a rational analysis of the likely rate of inflation over the next ten years? Is it even possible to make a more likely than not inflation prediction over a decade, so that emotional and psychological issues are the most important determinants in setting the break-even spread? How much of the current non-inflation protected price is determined by a flight to safety rather than rational pricing of future inflation risk?
Has the market made a reasonable prediction about the base rate for both the TIP and the comparable non-inflation protected security, that is, the rate before the inflation protection component of the TIP is factored into the equation? What will happen to the price of the TIP if the 10 year treasury goes from a 3.6% yield to a 5.6% yield in a year or so, by falling in price? Is concern about inflation just the latest soup du jour? How much impact is the FED's quantitative easing program having in distorting the market price of both the TIP and the comparable 10 year treasury? I am just a novice bond investor raising some questions for myself.
This raises a number of logical questions. Is the spread subject to mood swings rather than a rational analysis of the likely rate of inflation over the next ten years? Is it even possible to make a more likely than not inflation prediction over a decade, so that emotional and psychological issues are the most important determinants in setting the break-even spread? How much of the current non-inflation protected price is determined by a flight to safety rather than rational pricing of future inflation risk?
Has the market made a reasonable prediction about the base rate for both the TIP and the comparable non-inflation protected security, that is, the rate before the inflation protection component of the TIP is factored into the equation? What will happen to the price of the TIP if the 10 year treasury goes from a 3.6% yield to a 5.6% yield in a year or so, by falling in price? Is concern about inflation just the latest soup du jour? How much impact is the FED's quantitative easing program having in distorting the market price of both the TIP and the comparable 10 year treasury? I am just a novice bond investor raising some questions for myself.
I do believe that an important component of TIP pricing is the often temporary and fleeting perception of investors about the inflation risk to a fixed coupon bond. There was no concern a few months ago, as reflected in the break-even point being close to zero.
With more stories in the press about the potential inflationary impact of the fiscal and monetary stimulus, and the impact of quantitative easing on the value of the dollar, investor psychology has shifted from no break-even point to a 2%+ one. Another factor is the fall in the price, and rise in yield, of the non-inflation protected 10 year treasury since early March.
The TIP closed yesterday at $101.35, but it was priced at $100.36 adjusted for the dividend on 3/19/09
Since the spread is increasing, why hasn't the TIP done better? The only answer that makes sense to me is that the market is re-pricing the base rate of both the TIP and the 10 year treasury. On 3/19/09, the 10 year treasury closed at a price to yield 2.605% and yesterday it was yielding 3.621%. WSJ.com And I think that explains why the TIP has not done better as the break-even point increased. So, what is my point? The break-even point currently priced into TIP, which would require a greater than 2% inflation rate before it would prove advantageous over the non-inflation protected security, may be a poor prediction and the market may also have the base rate of both securities wrong.
With more stories in the press about the potential inflationary impact of the fiscal and monetary stimulus, and the impact of quantitative easing on the value of the dollar, investor psychology has shifted from no break-even point to a 2%+ one. Another factor is the fall in the price, and rise in yield, of the non-inflation protected 10 year treasury since early March.
The TIP closed yesterday at $101.35, but it was priced at $100.36 adjusted for the dividend on 3/19/09
Since the spread is increasing, why hasn't the TIP done better? The only answer that makes sense to me is that the market is re-pricing the base rate of both the TIP and the 10 year treasury. On 3/19/09, the 10 year treasury closed at a price to yield 2.605% and yesterday it was yielding 3.621%. WSJ.com And I think that explains why the TIP has not done better as the break-even point increased. So, what is my point? The break-even point currently priced into TIP, which would require a greater than 2% inflation rate before it would prove advantageous over the non-inflation protected security, may be a poor prediction and the market may also have the base rate of both securities wrong.
Personally, I would not even make a prediction with any degree of certainty about the average inflation rate over the next 10 years. I would guess now that it will be higher than 2%. I also believe that the base rate is far too low. That belief is keeping me out of buying more TIP now. However, if I had to choose between a 10 year non-inflation protected security and the TIP today, I would choose the TIP. (see also recent discussion in this post: Treasury Inflation Protected Securities as a Non-Correlated Asset)
4. The Young Investor and the Current Bear Market: While I am not a believer in buy and hold for all periods during an investor's life span, I would make the observation that a bear market in stocks is a good time for the youngsters to start buying for the long term with funds that will not be needed for 10 to 20 years, as would be the case for retirement accounts set up by someone in the their 20s or 30s for example.
When the DJIA was at 6500 in early March, and even at today's prices after a spirited rally, over a decade of stock price appreciation had been wiped out by the two bear markets of this decade. This kind of action at a minimum creates a better entry point for a new investor to implement a longer term buy and hold strategy for stocks. My main suggestion is that all investors, regardless of age, need to be cognizant that both bonds and stocks will fail as asset classes over long periods of time. But that is not an argument against buying stocks after this asset class has already failed for the buy and hold investor over the past 12 years.
The frequent longer term failures of stocks and bonds is a fact dismissed by the buy and hold crowd, and I would suggest that the young investors need to keep history in the back of their minds when making decisions in the decades to come.
To Professor Siegel: Time for a Re-Think
When the DJIA was at 6500 in early March, and even at today's prices after a spirited rally, over a decade of stock price appreciation had been wiped out by the two bear markets of this decade. This kind of action at a minimum creates a better entry point for a new investor to implement a longer term buy and hold strategy for stocks. My main suggestion is that all investors, regardless of age, need to be cognizant that both bonds and stocks will fail as asset classes over long periods of time. But that is not an argument against buying stocks after this asset class has already failed for the buy and hold investor over the past 12 years.
The frequent longer term failures of stocks and bonds is a fact dismissed by the buy and hold crowd, and I would suggest that the young investors need to keep history in the back of their minds when making decisions in the decades to come.
To Professor Siegel: Time for a Re-Think
5. Double Short ETFs as a Hedge- I Give Myself an A+ for the Concept and a D- in its Implementation/Sold PST: I frequently grade my performance as an investor, trying to assign a grade as objectively as possible without any involvement by my ego or emotions. When I decided to hedge my long corporate bond portfolio with the double short ETFs (TBT & PST) for the U.S. treasuries, TBT was around 36. TBT add TBT: Historical Prices I give myself an A+ on my reasoning at the time, which was to buy the TBT as a hedge against the inflation risk in my newly acquired long term maturity corporate bonds.
Those bonds were purchased at a time when investors were panicking, driving up the prices of the long treasuries and forcing even better quality investment grade corporates down in price and up in yield, creating a historically abnormal spread. So, I said to myself buy TBT which had been smashed due to the parabolic rise in the 20 year treasury price as a hedge for my corporate bonds bought almost entirely in the 4th quarter of 2008, and maybe I will make money both on the hedge and the corporate bonds, just by a narrowing of the spread.
This was explained in several prior posts. Rally In Long Term Investment Grade Corporates/TBT The reasoning proved correct so that is why I give myself an A+ on the theory part. I did not however implement the theory satisfactorily by buying enough TBT before the price jumped from about $36 to the current $55. So, in my implementation of my A+ concept, I will give myself a D- where it really counts.
Those bonds were purchased at a time when investors were panicking, driving up the prices of the long treasuries and forcing even better quality investment grade corporates down in price and up in yield, creating a historically abnormal spread. So, I said to myself buy TBT which had been smashed due to the parabolic rise in the 20 year treasury price as a hedge for my corporate bonds bought almost entirely in the 4th quarter of 2008, and maybe I will make money both on the hedge and the corporate bonds, just by a narrowing of the spread.
This was explained in several prior posts. Rally In Long Term Investment Grade Corporates/TBT The reasoning proved correct so that is why I give myself an A+ on the theory part. I did not however implement the theory satisfactorily by buying enough TBT before the price jumped from about $36 to the current $55. So, in my implementation of my A+ concept, I will give myself a D- where it really counts.
I mentioned in an earlier post that I would likely sell my 30 shares of PST, the double short ETF for the 7 to 10 year treasuries. I sold those shares at $57.52 making a few bucks on the buy in the 53 and change range. Buying just 30 shares of that ETF is part of the reason for the D- grade. Thirty shares is useless as a hedge to me, and the purchase has nonetheless absorbed over $1500 in capital which could be deployed in a CPI floater that pays interest.
6. Bernanke Testimony: The Fed Chairman is sticking to his low inflation forecast:
"In this environment, we anticipate that inflation will remain low. The slack in resource utilization remains sizable, and, notwithstanding recent increases in the prices of oil and other commodities, cost pressures generally remain subdued. As a consequence, inflation is likely to move down some over the next year relative to its pace in 2008. That said, improving economic conditions and stable inflation expectations should limit further declines in inflation."FRB: Testimony--Bernanke, Current economic and financial conditions and the federal budget--June 3, 2009
7. Dollar Index: As shown in the chart of the Dollar Index, the dollar has been in a rally mode of sorts since the NYSE close yesterday. (NYBOT:DX)
8. Manufacturing Inventories Continue to Decline: The inventory of manufactured durable goods continued to decline in April, for the 4th straight month, with a .9% decline or 3 billion dollars. Economic Indicators.gov It is important to work off the unwanted inventories that accumulated during the sharp decline which occurred in the 4th quarter of 2008.
9. Healing Process: I still believe that it will take a lot of time to heal the damage resulting from our near brush with another Great Depression. As of yesterday, the S & P 500 has risen 39.6% off its March low. Some would call that a bull market, and I will not disagree.
I would prefer, however, to assess it with an analogy. Since I am not a believer in the efficient market theory, I would prefer to refer to the market as a drunk, who occasionally goes on the wagon and frequently falls off it. In the early months of 2009, the market had an all night bender, woke up in early March, and said: "how did I get to 6500", sobered up some, and returned to the level more appropriate for our current environment. In other words, the market went too far down and made a fairly quick adjustment. We are still in a long term secular bear market in my opinion. We are at levels in the DJIA prevalent in February 1998: ^DJI
The VIX is still at elevated levels, indicating a heightened level of danger and risk for an individual investor. It could easily take 5 to 7 years to return to the DJIA level in early October 2007. I would expect that the market will have some choppy action now, with a best case scenario to be a return to DJIA 10,000 by the end of 2010. So, I am not exactly giddy when we are basically back where we started 2009 for the DJIA and slightly ahead in the S & P 500 (DJIA closed 12/31/08 at 8776.39; S & P 500 at 903.25).
I would prefer, however, to assess it with an analogy. Since I am not a believer in the efficient market theory, I would prefer to refer to the market as a drunk, who occasionally goes on the wagon and frequently falls off it. In the early months of 2009, the market had an all night bender, woke up in early March, and said: "how did I get to 6500", sobered up some, and returned to the level more appropriate for our current environment. In other words, the market went too far down and made a fairly quick adjustment. We are still in a long term secular bear market in my opinion. We are at levels in the DJIA prevalent in February 1998: ^DJI
The VIX is still at elevated levels, indicating a heightened level of danger and risk for an individual investor. It could easily take 5 to 7 years to return to the DJIA level in early October 2007. I would expect that the market will have some choppy action now, with a best case scenario to be a return to DJIA 10,000 by the end of 2010. So, I am not exactly giddy when we are basically back where we started 2009 for the DJIA and slightly ahead in the S & P 500 (DJIA closed 12/31/08 at 8776.39; S & P 500 at 903.25).
DISCLAIMER
I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. I have never worked for a financial institution and never will. In these posts, I am acting as an unpaid financial journalist and an occasional political commentator. I am also aggregating financial news stories that I view as important and providing readers of these posts with links to those articles, sort of a filtered, somewhat intelligent, free search engine. Any discussion made by me of particular securities is not a recommendation to buy or to sell. Trade at your own risk. Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons. The sale may before or after the post. Before buying or selling any stock, even one recommended by a trusted financial advisor, please research it and make up your own mind which is what I always try to do. Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news. In this post, and all others by me, I am merely describing my reasons for purchasing or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale. The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile. By way of example, it is unlikely that I will ever need the funds contained in my retirement accounts. Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments. Information contained in my posts has been obtained from sources believed to be reliable but cannot be guaranteed. It is always important to follow the investment process. the investment process/links to further information on canadian energy or royalty trustsInvestment Process Part II: Bonds and Bond Like Investments NOT A RESEARCH SERVICE/Add of PWE Last Week These posts by me do not constitute investment advice, nor shall they be construed as a guarantee of future results, or as an offer of any transaction in securities. All content in these posts is provided for informational and entertainment purposes only, and it is a form of entertainment for me. Anyone interested in a topic may want to review all discussions contained in the blog about it by using a relevant search term in the box at the top. Opinions are subject to change and they certainly evolve over time as information is assessed and analyzed for compatibility with prior opinions, the only process for a serious investor, and a topic of frequent discussion in this post.
No comments:
Post a Comment