Kass: Bonds May No Longer Rule

This blog post originally appeared on RealMoney Silver on Nov. 6 at 7:52 a.m. EST.

After yesterday's convulsive and disorderly $8.50 increase in the price of the 30-year U.S. Treasury bond, a once-in-a-generation short opportunity might now be occurring in the fixed-income markets. My experience is that the magnitude of Thursday's price rise is the sort of occurrence that ends an asset class's move.

I have initiated an iShares 20+ Year Treasury Bond Fund (TLT) short ($105) over the last two days. It is the essence of the anti-implosion trade and a statement that, among other things, oil will not remain under $50 a barrel and that, at some point in the near future, order will return to the world's markets.

I may very well be early -- I usually am! -- as the weight of the deflationary forces are overwhelming nearly every market, but I have almost always found that my best investment ideas are contrarian and not herd-following (and, again, are often early).

Here is my rationale:

• Milton Friedman wrote that inflation is everywhere and always a monetary phenomenon. He would be concerned today as the monetary base has expanded massively.
• The U.S. debt problem -- all entities have approximately $51 trillion of debt -- seems especially burdensome in an era when capital may continue to be dear. Next year, the ramping up of U.S. borrowing could collide with funding needs abroad (e.g., China's fiscal stimulus), which might push interest rates higher.
• When investors are better able to assess the depth and duration of the economic downturn, they will move out the risk spectrum. This could crush the Treasury market. Treasury supply matters only in bear markets, and if/when the bear market arrives, the huge supply increase could serve to aggravate the yield rise.
• While we remain on a slippery economic slope, I expect a number of credit-market-unfriendly policy moves -- including a massive stimulation program, the inevitability of an automobile rescue plan, increases in unemployment compensation and other targeted attacks -- aimed at fostering domestic growth.
• When banks become interested in lending again, they will sell their securities holdings or reduce the rate of securities purchases.
• Foreign central banks will begin diversifying their reserve assets again. It's already evolving into a secular trend. The U.S. dollar represents about 63% of world reserve assets, down from 70% only five years ago. In the same time frame, the euro has moved from 20% to 27% of the world's reserve assets.
• The three-month Treasury bill is now yielding below 10 basis points. It can't go much lower. The two-year note yields less than 1%. The 10-year U.S. note yields less than 3%, the lowest level in 50 years and down from 4.10% in October, and the 30-year U.S. bond rose by a record $8.50 yesterday, to yield 3.48%.
• Following the drop in the CPI and PPI, the spike in jobless claims and the bear market in stock prices, yesterday the TIPS market implied that the consumer price index will rise by less than 0.10% (on average) over the next decade. There is not much downside from there.

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Know What You Own: The TLT operates within the iShares trust family of ETFs, and some of the other ETFs in its field include the iShares MSCI EAFE Index (EFA), iShares MSCI Emerging Markets Index (EEM), iShares Russell 2000 Index (IWM), iShares TIPS Bond (TIP), iShares FTSE/Xinhua China 25 Index (FXI) and iShares Dow Jones U.S. Real Estate (IYR). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

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Doug Kass is the author of The Edge, a blog on RealMoney Silver that features real-time shorting opportunities on the market.

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