Shilling: Buy Treasury Bonds Again

01/13/2010 1:00 pm EST


Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, who racked up big gains in Treasuries for two decades, says the long bond looks attractive in a slow-growth economy.

We started recommending long Treasury bonds back in 1981 when we declared that “we’re entering the bond rally of a lifetime.”

The yield on 30-year Treasuries was 14.7% and our eventual target was 3%. Last year, yields blew through 3% to reach 2.6% at year’s end, so in January 2009 we declared “mission accomplished” and removed Treasury bonds from our recommended list.

But then Treasuries sold off, pushing the yield on the 30-year bond to 4.7% at the end of 2009. So, we’ve reactivated the strategy with our forecast of a return in yields to 3.0% or lower.

[That] may not sound like much, but the bond price would appreciate over 34%. On a 30-year zero-coupon Treasury, which pays no interest but is issued at a discount, the total return would be about 64%! In 2008, when 30-year Treasuries rallied from 4.5% to 2.7%, their total return for the year was 42%.

Our zeal for Treasury bonds has always been driven by the prospect for appreciation, not yield.

Treasury bonds way outperformed equities in the 1980s and 1990s in what was the longest and strongest stock bull market on record. [If you invested] $100 in a 25-year zero-coupon Treasury bond at its yield high (and price low) in October 1981, and [rolled] it into another 25-year Treasury annually, in November 2009, that $100 was worth $16,972 with a compound annual return of 20.1%.

In contrast, $100 invested in the Standard & Poor’s 500 [index] at its low in July 1982 was worth $2,099 in November for an 11.8% annual return, including dividend reinvestment. So Treasuries outperformed stocks by 8.1 times!

Many believe Treasury yields are headed up, not down. They also think the continual heavy issuance of Treasuries to fund the nonstop federal deficits will push up yields, In contrast, we don’t foresee the rapid economic growth needed to induce chastened banks to lend and cautious credit-worthy borrowers to borrow.

We do expect large federal deficits for many years, in part because of pressure on government to create jobs and restrain unemployment in a slow-growth economy. But those deficits will increasingly be funded by US consumers as their saving spree continues. Although stock market bulls salivate over the prospect that increased saving will mean more equity purchases, we believe most of the money will continue to reduce the immense debt consumers have accumulated in recent decades.

Since money is fungible, increased consumer saving will largely end up funding federal deficits. After-tax income is currently around $11 trillion, so a 10% saving rate, which we expect or higher in the next decade, would provide $1.1 trillion in funds.

As US consumers save more and curb spending on domestic products and imports, the trade and current account deficits will continue to shrink. So, foreigners will have smaller American current account deficits to finance.

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