Bubble in Short Term Treasuries
During the last two weeks we have seen incredible volatility in the markets. Fear and uncertainty is rampant which has people running to short term treasuries. Last week even saw the 3 month treasury yield go negative for part of the day. For those willing to keep their heads this spells potential opportunity (which means higher risk of course).
1. Buy Treasury Inflation Protected Securities instead of nominal treasury bonds. The 5 year treasury is currently yielding 3.06% and the 5 year TIPs has a real yield of 1.86%. This means if inflation is more than 1.2% a year over the next 5 years, the 5 year TIPs bond would be a better deal. The 10 year bonds have a spread of 1.8%. Considering the massive debt and deficits coming our way, I would be amazed if inflation stayed that low over the next 5 to 10 years. Historically, there have only been two periods in the last 80 years like that and both of those were before we went off the gold standard to fiat money. With that said, be prepared for a year of two of potentially low inflation while the economy works its way through its current troubles.
2. Buy Municipal bonds instead of nominal treasury bonds. Municipal bonds are now yielding more than treasuries at every maturity. Municipal bonds have greater credit risk than treasuries, so being properly diversified is important (i.e., use a fund). They are also less liquid (another reason to use a fund). In the very short term, it is mainly the municipalities with large real estate drops that will have significant problems. In the long term however, many municipalities have woefully underfunded their pension plans and will likely run into greater difficulty as the boomers retire and live longer than expected so keep maturities relatively short (no longer than an intermediate fund).
3. Buy a GNMA fund instead of nominal treasury bonds. GNMA securities currently have a 2% premium over equal duration treasuries. Considering GNMA are federally insured, the only reason for a premium is because of the mortgage put option (i.e., people refinance when rates go down and keep their mortgage when rates go up). The normal premium for this is .5% to 1%. So a 2% spread is unusually high. The main risk here is that these funds are intermediate term instead of short term which means they are more subject to interest rate risk so if interest rates rise significantly this will negatively impact your principal.