Treasury notes sure haven’t been a safe haven so far in 2013, and where yields go next is anyone’s guess.
Long-term investors still will maintain an allocation to fixed income regardless of the latest gyrations in the yield curve, if only to help smooth out volatility in the equity side of their portfolios. But what should more tactical investors (and income seekers) make of the latest plunge in bonds — and therefore jump in yields? Has the so-called Great Rotation out of bonds and cash into stocks made the safe haven of Treasury notes a death spiral?
There’s nothing like the allure of rising prices to get investors to chase an asset class — and the market’s 2013 melt-up is no exception.
As the U.S. equity markets flirts with all-time highs, prices on benchmark Treasury notes are taking the fall. The yield on the 10-year Treasury is up above 2% — a level it last sustained almost a year ago. (But back then it was on the way down, to record lows around 1.4%.)
Bond prices and yields move in opposite directions, remember, meaning that returns in U.S. debt have been punished so far this year. Stocks, meanwhile, have been doing great. As of Feb. 12, the S&P 500 generated a total return of 6.8% for the year-to-date, according to S&P Dow Jones Indices. Treasury returns, by comparison, have been dismal.
The longest-dated Treasurys — those with maturities of 20 years or more — have lost 4.2% for the year-to-date, according to Barclays. Treasurys coming due in 10 to 20 years are off 2.4%, while 7-to-10-year Treasurys have lost 1.5%.
At the same time, however, more attractive bond prices — and, importantly, higher yields — just might make Treasurys more attractive for new money.
The iShares Barclays 20+ Year Treasury Bond ETF (NYSE:TLT), for example, has lost more than 3% year-to-date. But that has pushed up the yield up to a not-too-shabby 2.8%. The iShares Barclays 7-10 Year Treasury ETF (NYSE:IEF), meanwhile, is off 1.3% but now yields 1.8%.
True, the current trajectory of stocks and bonds suggests fixed-income prices have farther to fall, making yields even more tempting at those lower price levels. Sadly, you can’t time the market.
Furthermore, the whole Great Rotation theme — where Americans pull cash out of money markets and bonds and rush into stocks — doesn’t really apply to Treasurys and other taxable debt anyway, writes Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock:
“U.S. investors directly, or indirectly through funds/401ks, own only 18% of the U.S. taxable fixed income market, leaving the majority of ownership outside of the ‘Great Rotation’ debate.”
Indeed, the Federal Reserve and foreign holders account for nearly 55% of the ownership of the Treasury market. And a huge portion of what’s left after that is held by insurance companies, pension funds and banks.
As Rosenberg notes:
“These funds explicitly manage to a liability and for this reason interest rate risk cuts both ways: rising interest rates reduces the value of the asset and the liability. For these categories of bond holders, the implications of rising rates are less clear than that suggested in the ‘rotation’ theme for the typical retail investor.”
In short, the risks posed by any Great Rotation are both overly simple and overblown for Treasury securities.
Finally, don’t forget that bond yields have backed up steeply many times throughout the recovery — only to come crashing down again.
TLT and other Treasury ETFs are by no means a screaming buy these days — but they sure are more attractive than they were just a few months ago. And don’t be surprised if a seemingly annual spring-and-summer swoon in the stock market has investors bidding up prices and crushing yields in Treasurys yet again.
As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.