NEW YORK (TheStreet) -- It's ironic that while pundits and politicians are fulminating about our nation's debt crisis, the top-performing asset class in our public financial markets has been U.S. debt securities.
facing a debt crisis have seen the value of their bond issues drop as investors grow concerned about the risk of default and buyers of the bonds demand a higher yield to compensate them for taking that risk.
The U.S., however, is a different animal. On the day
Standard & Poor's
cut its triple-A credit rating last summer, the value of U.S. Treasury bonds actually rose in spite of the country's political gridlock, its spiraling entitlement costs, its foreboding demographic trends, its total debt that now amounts to more than $15 trillion (over 103% of GDP), and its annual budget deficit approaching $1.5 trillion.
Despite this precarious fiscal position, the market doesn't look worried about a U.S. debt default -- and with good reason. For all its problems, the U.S. remains a wealthy nation, and its economy is in relatively good shape compared to the rest of the developed world. Moreover, it enjoys the privileged position of printing the world's reserve currency, the almighty greenback. This cuts the country plenty of slack to run up debts and print dollars to stimulate its economy and meet its obligations, and that's what it has done.
Now, the yield on the 10-year Treasury bond -- the investment world's benchmark for a risk-free return rate -- has set record lows as global economic devastation threatens. Investors, still feeling the burn of 2008's financial collapse, are fleeing the volatility of the stock market for the promise of capital preservation in Treasuries and other fixed income assets.
For some investors, Treasuries and other bonds are certainly appropriate, and most investors should have some allocation to fixed income in their portfolio. But many of those piling into the bond market, particularly Treasuries, are now are making a mistake. Treasury bonds are in the midst of the market's latest asset bubble, which will pop sooner or later.
At this point, some readers may be thinking, "Hey, I've been hearing this
for a while, but it keeps turning out to be wrong. Yields keep going lower, and bond prices keep rising." True, but that's the nature of an asset bubble. They're caused by a perfect storm of events that allows them to keep ballooning, appearing to prove the skeptics wrong and winning new converts. That's what makes them so dangerous.
Let's consider what forces could be driving a bubble in Treasury bonds. Some note that fear is leading investors into the Treasury market, and only greed can cause an asset bubble. I disagree. Fear and greed are both emotional forces that motivate investors to take certain actions that lead to the mispricing of securities. In this case, fear is driving investors into the Treasury market and inflating the bubble.
Another important factor is also at work. The Federal Reserve is taking extraordinary monetary policy actions to push down short- and long-term interest rates in an attempt to stimulate economic activity and promote higher employment. They want to entice businesses, entrepreneurs and consumers to borrow money at low rates and make investments and expenditures that will create jobs. They also want to encourage savers who would sock away their money in safe places for a modest yield to take on more risk in order to generate the income they need by buying equities or lower-rated bonds (the policy hasn't had much success).
In pursuit of these goals, the Fed has gone so far as to tell the markets that it won't raise rates until at least 2014. This, along with its own purchasing activities in the Treasury market, has convinced speculators that rates will continue to go lower and prices higher, and this introduces the element of greed to the equation.
Many people accuse the Fed of causing the housing bubble with its easy-money policies in the last decade. Well, the Fed may now be causing yet another asset bubble, this time in the Treasury bond market.
I don't own any Treasuries, so I have missed out on the gains, but I continue to believe that stocks are a much wiser move for the long-term investor. Anyone who is looking for income yield can find equities with far more attractive yields than Treasuries. In fact, even if the stock market falls again in the short term, your odds of enjoying substantial capital appreciation as an equity holder in a solid U.S. company over the next 10 years from current prices are far higher than they are in the bond market, particularly in Treasuries, where any modest move higher in interest rates will cause prices to drop.
, for example, currently pays a 2.2% dividend yield, more than 50 basis points higher than the current 10-year Treasury yield. A Xerox bond maturing in 2039 currently yields 5%, while the stock offers a 15% free cash flow yield and trades well below its book value.
Less risky stocks such as
Procter & Gamble
Johnson & Johnson
are also available that offer a far more attractive yield and a far superior risk-reward profile than U.S. Treasuries at current prices over the next 10 years.
It may seem that Treasuries offer a safe haven, but if you're thinking about the long term, as any intelligent investor should,
This commentary is from an investment professional with Clear Harbor Asset Management who is a participant in TheStreet's expert contributor program.
Follow me on Twitter @NatWorden
Worden and/or his firm hold positions in XRX, TGT, WAG, WMT, PG and JNJ.
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