For the better part of 15 months, I have pounded the table for longer-term U.S. treasuries. Most financial pundits thought that I was nuts in December of 2013; they debated my scarcity premise throughout 2014 and they dismiss my relative value argument here in 2015. About the only concession? The talking heads have often acknowledged that if the “poop” hits the propeller, the proverbial flight to quality would involve super-sized demand for the perceived safety of U.S. sovereign debt.
Nevertheless, there has been more conversation about people missing out on the opportunity to short oil or buy a 2% stock dip than investors neglecting opportunities in federal government IOUs. From my vantage point, however, the prospects for increasing long bond exposure have not been quite as appealing since the iShares 20+ U.S. Treasury ETF’s (TLT) 50-day trendline crossed above its 200-day one year ago.
When professionals erroneously slam the possibility of adding treasuries to a mix, they typically focus on ultra-low yields alone. Yes, the yields are deplorable. Heck the 10-year barely competes with the dividend of the S&P 500 SPDR Trust (SPY). And yes, bonds are extremely overvalued from a simplistic perspective of the payment of interest.
What they fail to recognize, of course, is that roughly half of our nation’s public debt is owned by foreign central banks and foreigners; 20% is owned by our very own Federal Reserve. Pensions, mutual funds, banks and insurance companies own most of the remaining securities. Now, think about it. Foreign central banks earn more on dollar-denominated AA/AAA treasuries than they earn on lower yielding, lower-rated assets in depreciating currencies; the relative value means there is little reason to sell. The Fed has no intention of dumping treasuries on the market for fear of killing favorable borrowing costs. In the same vein, pensions as well as bond mutual funds have rules about their allocation, while banks would rather earn 3% from a risk-free 30-year treasury than 3.5% from Joe and Josephine Shmo’s mortgage.
It follows that the demand for U.S. treasuries across the globe is extraordinary, yet the supply is undeniably limited. This is scarcity. What’s more, when you add in other factors – relative value against scarce developed world bonds, need for perceived safety, economic deceleration – the “Fed is raising overnight lending rates” counter is entirely myopic.
Perhaps ironically, some stock advocates are using scarcity to explain why stocks are poised to continue their remarkable run without a hitch. In brief, believers posit the following: Retiring/semi-retiring baby boomers are set to live well into their eighties and nineties, meaning that the demand for stocks held over 30 years will be higher than anyone could have imagined. On the other hand, the percentage of available share in the S&P 500 have dwindled considerably due to remarkable share buyback activity by component corporations. In fact, they argue, the laws of supply and demand pretty much trump traditional measures of valuation and, for that matter, human psychology in panics.
One such stock advocate is an “almost famous” commentator who I respect (even when I do not agree with him). Joshua Brown of the Reformed Broker wrote about scarcity of stocks on 2/25:
“They’re living way longer than their parents did and way longer than they’d originally expected to. 25 percent of them will make it into their nineties. What do they need more than anything? It sounds crazy, but they need stocks. Bonds aren’t going to cut it for a thirty year retirement…