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The End of a Long, Winning Strategy

01/12/2009 1:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says his 27-year strategy of buying long Treasurys has just about played out after yielding huge profits.

Going into this year, the good news is that all 13 of our strategies for 2008, made a year ago, worked. The bad news is that all 13 worked. Some of them have been fully achieved with little or no potential gains remaining, while others are partially exploited.

That’s certainly true of number 13, “buy long Treasury bonds,” our 27-year favorite [strategy]—ever since 1981, when the yield peaked at 14.7% and we declared that “we’re entering the bond rally of a lifetime.”

And note that we have always concentrated on 30-year maturity Treasury bonds, not two-, five- or ten-year maturity notes. The longer the maturity, the greater the appreciation as interest rates fall. Furthermore, Treasurys are the best credits in the world, considered riskless and therefore the standard by which all other fixed-income securities are compared.

Over the course of 2008, the yield on 30-year maturity Treasurys, the long bond, fell from 4.5% to 2.6% as the price jumped by 37.5%, so with the interest coupon, the total return was 42%. Wow! Very nice compared to losing 39% in US stocks!

Our forecast made over ten years ago of a 3.0% yield on 30-year maturities was more than achieved as they rallied to 2.6% at year’s end. “The bond rally of a lifetime” is over, and it’s hard to say farewell to a great friend that has rewarded us so well since 1981. We feel deserted, bereaved.

But this doesn’t mean that the long bond isn’t worth holding. As the recession deepens, the Federal Reserve will no doubt buy longer-dated Treasurys, as it has clearly stated. Treasurys will probably continue to be the safe haven in a world of extreme financial uncertainty. With deleveraging, credit-worthy borrowers are few, so lots of money is available to buy Treasury bonds.

And this year's deflation, which we expect to become chronic, makes even a 2.6% yield attractive in real terms. With 2% deflation, the real return is 4.6%—probably a standout compared to other investment returns.

Deflation is under way, and is quite likely to continue throughout this year. Recent and continuing commodity price declines will depress general price indices as they work their way through the economy. Retail prices will continue to be weak as retailers offer bargains to unload excess inventories and generate sales.

Many, of course, expect a return to inflation, at least by next year, due to the massive funds that central banks are pumping into financial institutions and by the huge issuance of government bonds to cover mushrooming deficits.

But banks will probably be scared to lend those funds until economies here and abroad recover, and will continue to rebuild capital for years to come under strong regulatory pressure. When lending does revive, central bankers, with their congenital fear of inflation, will undoubtedly retrieve tons of liquidity.

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