Although my daily column is entitled “Stocks to Watch,” stocks are a sideshow today (May 30th). The things worth watching right now are U.S. Treasury bond yields and crude oil prices, both of which are sinking like a stone.
In fact, the iShares Barclays 20+Year Treasury Bond ETF (NYSE: TLT) jumped above $126 today — an all-time high price that surpassed the $125.03 intraday level reached on October 4, 2011.
That’s impressive, but TLT has only been around since July 2002. Even more impressive is the drop in the 10-year U.S. Treasury bond yield (Chicago Options: ^TNX) to 1.619%, its lowest level in at least 60 years! Bloomberg’s chart only goes back to 1993, but it still demonstrates the historic period we are living through right now:
10-Year U.S. Treasury Yield
German 10-year bond yields also hit a record low at an even lower yield level of 1.35%. The “risk-off” trade of hiding in the debt of relatively strong sovereign credits is currently operating at full force.
Crude oil prices are nowhere near all-time lows, but they are at seven-month lows. Continued uncertainty surrounding a potential Iranian nuclear crisis is probably propping up oil prices above where they otherwise would be. On the negative side, OPEC production in May ramped up to its highest level since 2008 and U.S. oil inventories are at their highest level since August 1990, a 22-year high. With the West Texas Intermediate (WTI) price falling below the psychologically important $90 level, it looks like a retest of the $75-$80 level that has acted as a price floor since 2009 is likely:
West Texas Intermediate Crude Oil Price
Source: BloombergIf hedge fund manager Barton Biggs is correct, oil prices won’t bottom until $60 because Saudi Arabia plans to flood the world with oil in an effort to bankrupt the economy of arch-enemy Iran.
Europe Debt Crisis Won’t Go Away
Why are U.S. bond yields and crude oil prices dropping? One word: Europe — the debt crisis that just keeps on giving. Not only do we have a Greek election on June 17th that could usher in the anti-bailout Syriza Party and cripple the Euro, but Spain’s banking system is in serious trouble with the European Central Bank (ECB) rejecting the Spanish government’s proposal for a bailout of newly-nationalized Bankia. The Egan-Jones credit rating agency downgraded Spanish sovereign debt to B from BB-, its third downgrade of Spain in less than a month! Felipe Gonzales, the longest-serving prime minister in Spain’s history from 1982-1996, stated on May 30th that Spain faces “a situation of total emergency, the worst crisis we have ever lived through.“
The yield on Spain’s 10-year government bond has risen to 6.67%, very close to a new Euro-era high. If you look at a price chart of the Spanish 10-year bond yield, it looks like a reverse-image of the U.S. 10-year bond yield. The money poring into the “risk-off” U.S. Treasury market has partly come from those fleeing “risk-on” trades like the Spanish bond market:
10-Year Spanish Bond Yield
According to Nomura Securities, the European debt crisis is likely to peak (i.e. get worse) sometime over the next few months and only then will the ECB do the massive quantitative easing that is necessary to solve the problem:
Since last year we’ve had this idea that we’re going to be reaching a peak, that Q2/Q3 will be a decisive moment for the crisis in Europe. We are seeing the manifestation of crisis accelerators.
Over the last two months, we’ve seen a new face of deterioration. The most important element is what euro investors themselves are doing. It is very, very rare to see investors accumulate foreign assets in a bear market, so this tells me that we are essentially entering a new, even more dangerous point in the crisis.
U.S. Recession is Still a Possibility
China’s economy continues to slow down, with bank loans falling short of government targets for the first time in at least seven years. The good news is that the U.S. economy is somewhat insulated from the problems in Europe and China. So, it may make sense in the short term for investors to focus on U.S. companies with little international exposure. The bad news is that those pesky forecasters at the Economic Cycle Research Institute (ECRI) recently affirmed their U.S. recession call, saying that weak personal income is the key:
Year-over-year growth in real personal income has stayed lower than it was at the beginning of each of the last ten recessions.
Since its initial recession call last September, ECRI has been wrong, but that doesn’t mean it couldn’t end up being right, especially if Europe blows up or the U.S .Congress doesn’t do anything to prevent the “fiscal cliff” of higher taxes and spending cuts primed to take effect at the beginning of 2013.
U.S. Treasury Yields Could Go Either Way
We are living in historic times. Although U.S. Treasury bond yields are at extremely low levels, it is exceedingly dangerous trying to call a bottom. According to a Barron’s Magazine April poll of “Big Money” institutional investors, only 2% of respondents were bullish on U.S. Treasury bonds. Since when has a bear market ever started with only 2% bulls? Never.
Longer term, I agree that U.S. Treasuries will decline in price (i.e., yields will rise) because a sub-2% yield on 10-year U.S. Treasuries has never been sustainable historically and only makes sense in a deflationary economy. Fed Chairman Ben Bernanke has emphasized he will never let deflation happen and will drop money from helicopters if necessary. That said, as John Maynard Keynes famously said, markets can remain irrational longer than you can stay solvent, so I wouldn’t make a huge bet that yields will soon rise. All you have to do is study Japan’s experience to understand that bond yields can remain extremely low for many years. According to Wharton finance professor Krista Schwarz:
It’s virtually impossible to forecast future yields. One can talk about risks to the upside and risks to the downside, but both risks always exist.
Bottom line: Buying long-term U.S. Treasuries at their current low yields makes no sense, but neither does shorting them given the fact that the European debt crisis could get worse before it gets better.
Some asset classes are best left alone during periods of extremely high uncertainty. Right now, U.S. Treasuries are just such an asset class.