Could Tsys Be the Next Bubble?

By Dan Burrows

We may be through the looking glass here, people. Treasurys, the world's invincible vault of wealth and stability, are acting pretty weird these days. They're behaving like stocks, or at least how stocks used to behave.
Remember, Treasurys are debt instruments, not equities. They're supposed to be kind of boring and not terribly rewarding. But then what do you expect from Uncle Sam's big snuggly security blanket? After all, Treasurys are "riskless," right?
Well, yes and no. They simply can't default, the thinking goes, because the government actually owns the machine that prints money. So you lend the feds some cash, they guarantee your money back, and they throw in a little vigorish for your trouble. (Although those meager yields won't help much later when all this fed paper eventually fuels inflation.)
But we digress. No risk, no reward, whatever. When stocks go down, bonds go up. This time it's different. So much cash has poured into Treasurys that yields are scraping the deck. And bond prices? They're up, up and away. (Remember, when bonds trade, their prices and yields move in opposite directions.)
Which brings us to this: Has the world's panicked flight to safety become a mass exodus to insanity? Could Treasurys (gulp!) be the next bubble?
No doubt it has been a strong and long bull run for Treasurys. The total return generated by the Treasury market was 5.1% in November, making it the best month since 1981. Back then the yield on the 10-year note was 15%, wrote David Rosenberg, Merrill Lynch's North American economist. Ahem, but today the yield on the 10-year note is dabbling with, uh, 2.7%.
"What a great time it has been to have been long the Treasury market as we head into the home stretch of this massive bull market," Rosenberg wrote Nov. 28. "And to think that the asset class most despised and the most underowned in pension fund, household, commercial bank and mutual fund portfolios is the one generating the greatest returns."
It gets weirder. For the first time in 50 years the dividend yield on the S&P 500 index (it's 3.7%) rose above the interest rate on the 10-year note. Historically this ain't how it's supposed to go. Over the long haul stocks generate better returns than bonds, but bonds are less risky and supply a steady stream of fixed income. As one goes up, the other goes down, but to this degree, and in Treasurys, no less?
Here's some data that will make equity investors throw up in their mouths a little bit. The Dow Jones Industrial Average, S&P 500 index and Nasdaq Composite index have bled out 35%, 40% and 45%, respectively, year-to-date. Now take a look at the total returns generated by various U.S. Treasury indexes.
It's almost too good to be true, as Merrill Lynch's Rosenberg was careful to point out. "Investors should understand that while we maintain a constructive posture, Treasurys have moved into overvalued territory," he wrote.
Not that it has to end anytime to soon. Helicopter Ben is circling his Huey, firing cash down around the perimeter of a hot LZ. Meanwhile, down on the ground, sheer and ongoing financial terror is enveloping the globe.
Almost perversely, that's great news. It means this overvalued condition is likely to persist, Rosenberg says, "as the Fed, households and institutional investors emerge as large-scale buyers, even as foreign central banks pull back."
Ugh. This scenario seems spooky and familiar. Are Treasurys setting up for that classic mania-turn-to-bubble phase we've seen too often and too recently? Tech stocks in 2000. Real estate in 2006. Once the general public crowds itself 10 deep at the craps table, it might be time to take some winnings off the table.
SMARTMONEY.COM