Sharpening my pencil to evaluate my 60+% position in 30-year treasuries. The yield has been plummeting since the Fed's announcement, falling to around 2.8%. Previously I had said I would look to sell my position at a yield below 3%.
Given the Fed's anticipated buying of 20-30 year treasuries, a growing banking crisis in Europe, slowing growth in China, and on-going political gridlock and economic concerns in the U.S.; it is difficult to point to a "proper" yield. So, based on my contrarian Sagflation thesis I believe there are strong fundamental reasons driving the price changes in the markets, I need to look at the timing of my exit strategy from a different angle. Luckily, there is a recent severe drop in 30-year yields from which to learn lessons.
On December 18, 2008 the yield on the 30-treasury closed at 2.54%. Three days earlier it was up around 3%. This event occurred almost three months before the bottom of the SP500 on March 9, 2009. By March 2009 the yield on the 30-year treasury was back above 3.5%, hurting investors who had bought the treasuries for safety reasons while equity market declined between December 2008 and March 2009. During this time there were similar fears about the banking sector and economic slowdowns around the world. From this angle, there is an argument to sell my treasury position well before an anticipated bottom in the equity markets.
One of the biggest signs of "capitulation" in the equity market is a large spike in volume. One interpretation of a capitulation is investors giving up hope of a rally combined with forced selling either to try and protect performance, redemption of money in funds, or margin calls. The day of capitulation may not coincide with the actual market bottom, but it is likely reasonably close. Through this lens we see the largest one day volume in the SP500 occurred on October 10, 2008 when volume spiked to 11.5 billion shares, characterized by wild 7% swings. This event likely coincided with investors shifting to a more cautious stance. It also preceded the bottom of the 30-year yield by about 2 months. While the markets have been volatile, the volume has not come close to 11.5 billion, instead clearing 6 billion a few times. In my view, this suggests investors are holding positions as they hope for economic conditions to turn-around. In other words, I believe we are only at the beginning, implying yields drop further and 2012 is fairly bumpy.
Looking more closely at the events around December 18, I was reminded that the Federal Reserve cut interest rates from 1% to 0-0.25% on December 17, 2008. Included in the announcement was the phrase "the outlook for economic activity has weakened further", adding that
the rates would stay at their current levels for some time. This point reminds me that I should ask the question, "Will the Fed release an even more negative statement than what it did this week?" Anything is possible. There is some speculation that the Fed may print more money through QE3 should economic indicators continue to deteriorate. If the Fed made this announcement I would likely sell my treasury position and begin considering buying commodity-related investments due to increased likelihood, in my view, of rising inflation. QE3 would likely initially cause treasury yields to fall due to the added buying pressure from the Fed, but longer-term the inflationary pressures it would create would likely cause yields to rise, in my opinion.
Looking at the news around March, 2009, when the stock markets bottomed, I was reminded that generally the economic indicators were negative. Investors, already hurt from a significant slide in the markets, were expecting the worst and in full-on survival mode. Both macro indicators and micro indicators from companies were negative. Personally, I don't think we are there yet. News out of companies remains generally okay and we have not actually tipped over in Europe or Asia. Investors remain hopeful it can be avoided. In my opinion, we may not get there until June 2012 as the full ramifications of bank failures in Europe and a slowdown in emerging markets take time to be understood.
Bottom line, I plan to exit my treasury position in the next few months. I am looking for one of the following occur: (1) 30-year treasury yields fall below 2.5% (a technical support level since it represents the low in 2008), (2) a major macroeconomic shock of the size of European sovereign debt defaults and bank failures, (3) a 30+% pullback in the equity markets, or (4) a Fed announcement about printing more money under QE3.
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