2-Year Treasuries? Love Em Or Leave Em

I’ve spent over 60 years on the Street, but never carried Treasury bills until recently. Now I own a garbage bag full of ‘em, losing money on paper and lamenting how wrong you can be in a conservative play and lose serious money, unless you hold to maturity.

After all, 2-year Treasuries, do mature at par and wipe out any losses. There is, of course, opportunity cost lost. What if you had invested in a 5 dollar ragamuffin that doubled or tripled during your same holding period in Treasuries?

Think of all pie chart investors, who just want to preserve family wealth stuck in a construct of 60% equities, 40%, fixed income paper. Houses starting with JP Morgan carry trillions of clientele assets which hardly budge. Last year was a baddie, down 16% in most portfolios.

And, yet, the spread between 2-year and 10-year Treasuries impressively widens, now over 100 basis points, a 30 year record. It’s beginning to get some attention as a bearish indicator, but nobody’s pounding the table, so lemme pound the table.

Why is serious money being injected into low yielding 30-year Treasuries? The sole rationale I can dredge up is that such players want to bet that recession is around the corner so be in place when it happens. Why can’t 10-year Treasuries yield 2% instead of the current 3.4%?

Back to my trusty chart book: The 30-year Treasury bond yield traces a gigantic sombrero formation. It peaked at 15% in 1983 during the Volckner tightening grind. But, this bond traded close to a zero yield as recently as 2020. Anyone buying in today must feel strongly that bond rates are headed towards 2%, even lower, while the country experiences deep recession.

I’ve bought this recession forecast. The averages stand 20% overpriced today. We should be headed towards a major correction that takes the market down from 20 times projected earnings to my reality of 16 times. Just you wait and see.

The history of 10-year Treasury yields going back 60 years shows a trendline approximating 5%. Only the financial market meltdown of 2009–2010 took yields down convincingly below 5%. Today, the10-year Treasury yield is just 3.74%. It seems to me that long Treasuries have already discounted the next recession coming around the corner.

Only prolonged recession negatively impacts so-called junk bonds. Consider, yields spiraled down relative to 5-year Treasuries from 900 basis points to 300 basis points. The time elapsed approximated three years, 2012 to 2015. Such downside volatility surprised me, such compacted intensity. Buying into such extreme-downside volatility is the contrary course to follow.

When I looked at my charts on oil futures during this volatile period of 2008-2014 futures followed the same downside trajectory as bank stocks, from $140 to $30 a barrel in 2009, comparably lethal. It reinforced my point of view that the spread between BB debentures and 5- and 10-year Treasuries favors BB paper, for its absolute yield over 5% and a comfortable spread, historically speaking, with Treasuries and other volatile fixed income properties. (What a mouthful!)

We may see zero to negative yields not just on money market paper but in Treasuries stretching out to five years.Think of what happened in Japan years ago. If so, my high-yield debentures with average duration of five years could turn golden. Conversely, anyone investing in Treasuries today not only receives a next-to-nothing yield, but probably faces more prospective downside risk than in BB corporates.

The history for 10-year Treasury yields going back 60 years shows a trendline approximating 5%. Only the financial market's meltdown during 2008-2009 finally took yields down provocably below 5%. When dealing with personal money you feel the pressure of being wrong sided in a trade that waxes negative for months, even years.

Lemme get to Sidney Homer who was in the sixties, a senior partner at Solomon Brothers. I’d visit him for breakfast in the partners’ dining room at Solomon around 7am. I guess they wanted to watch their ships sailing in off the Atlantic Ocean. Back in Sidney’s office the window sills were bedecked with charts of interest rate disparities between long dated and short dated Treasuries and other financial notes.

Sidney would then discourse on the history of widening and narrowing yield disparities, what the bond business is all about. You needed courage to play the variances when historically they got too far out of line because of the market’s momentary hysteria-sort of what we’ve got today.

Sidney would declare “nothing’s changed. There was the same hysteria back in Biblical times when the wheat crop failed in Israel.”

They hadn’t the foresight, like the Egyptians, to build warehouses for surplus wheat. So the Egyptians sold Joseph’s brothers wheat at a big premium. The family paid in gold.