No Bubble with US Treasurys Anytime Soon
Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Marshall George Zhukov, the brilliant Soviet military strategist and architect behind the victory over Nazi Germany in World War II, once remarked that, "Quantity has a quality all of its own."
What Zhukov was noting was that sheer mass can impose its will in a variety of ways over qualitatively superior but numerically inferior counterparts. When a certain level of competence is achieved, the numerically superior opponent can easily recover from more mistakes and rebound much quicker: overall, the margin for error is much greater.
This has been happening with the rising value of US Treasury bonds. Despite high unemployment, a collapse in the housing market, a banking system on life support and a downgrade by Standard & Poor's, the exchange traded fund for long term US Treasury bonds, iShares Barclays US Treasury 20+ (NYSEMKT: TLT), has produced a cumulative return of more than 50% since the financial meltdown of September 2008.
Over the same period, the exchange traded fund for the Standard & Poor's 500 Index, SPDR S&P 500 (NYSEMKT: SPY) has posted about a 6% cumulative return.
Over the last year, iShares Barclays US Treasury 20+ has risen by 38.75%. The SPDR S&P 500 exchange traded fund has increased by 4.18%. There are many reasons for this performance by US Treasurys and it should continue as Federal Reserve Chairman Ben Bernanke has become quite adroit at marshalling the resources at his disposal as the world's central banker to impose his will and achieve policy objectives.
As bad as the financial conditions are in the United States, the rest of the world is even gloomier for any economy of significance. Europe is in a recession and will not be pulling out any time soon. Japan has been in a recession for more than a decade and there is no reason for any optimism in the years, if not decades ahead. The currency for India just hit a new low due to the frail economic conditions of the nation.
In China, the economic growth rate is falling without anyone having any real clue as to whether or not the country is in a "hard" or "soft" landing as the data from Beijing is seemingly cooked. The falling price of industrial commodities in which China is the leading importer such as oil, copper and coal certainly point to a hard landing in the People's Republic.
Lower commodity prices traditionally strengthen US dollar denominated financial instruments. Cheaper oil results in less US dollars being exported to pay for foreign crude, which results in more economic growth in America rather than OPEC nations. This should continue as North America is now the world's biggest oil producing region.
China is the largest consumer of copper in the world and Europe the second largest user, so demand for the Red Metal is falling from declining economic growth in these areas. Usage in China is so low that Beijing has discussed exporting from its stockpiles. Oil is falling due to greater production in the United States and less demand in Asia and Europe: no mystery here, basic supply and demand. Coal is plunging from cheaper natural gas, lower priced oil, and slumping economic growth in India and China, two of the biggest customers.
In addition to having a more stable economic outlook, manifested by the strength of the currency, the United States controls global monetary conditions with Bernanke at the helm. Currency swaps from the Federal Reserve have re-capitalized the European banking system. While mistakes have been made, the overall magnitude of the US Dollar in global commerce has allowed for interest rates to remain low and for the American economy to recover from The Great Recession. The only financial instrument that comes even close to having the depth for those needed operations are US Dollar denominated assets in various forms.
It is the sheer mass and liquidity of this capital market that provides the strength of US Treasury securities. While it can be profitable to carry trade with the Australian Dollar or Brazilian Real or utilize the Swiss Franc as a safe haven asset, when this is done on any sizable scale the value of the currency is completely detached from fundamental economic conditions. That never lasts as the central bankers of these nations will retaliate, which results in an asset bubble eventually being created; and inevitably being burst. There is a reason that China and Japan both still own over a trillion each in US dollar denominated assets.
Federal Reserve Chairman Ben Bernanke has pledged that low interest rates will be maintained until 2014. He can basically do what he wants to ensure this and has proven that in recent years, whether through Quantitative Easing 2 or Operation Twist. Despite that public declaration of position by the world's global central banker, a short float of 55.07% has been established against the iShares Barclays US Treasury 20+ exchange traded fund. When the United States was downgraded by Standard & Poor's last summer, the TLT was trading around $95. Now it is over $125. While everybody loves an underdog, sometimes it pays to go with the biggest and the best.
jonathanyates13 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
