Saturday, December 27, 2008

Best Year for Bonds

All blog entries at Rotten Investments are subject to our DISCLAIMER.

You wouldn't expect an article like this ("Bonds set for best year in over a decade") to come as good news for someone who's short Treasury bonds. However, I am thrilled with this article.

Every financial bubble we've seen in the past decade has been formed by a good idea taken too far. The boom and bust started out with a good idea , commerce online with lower barriers to entry, that got taken too far. In 2004 and 2005, asset allocation towards real estate, always a "safe" bet, was a good idea that got taken too far. This past summer, buying oil futures in the face of unrelenting demand and tight supplies was a good idea... that got taken too far.

Every time you see too many people piling into a good idea, chances are, it's going to get taken too far. The Treasury bond market will be no exception. The allocation of capital away from stocks and into bonds is a good idea, at the beginning of a panic. However, once everyone has piled into bonds, they no longer represent a safe haven. When bonds were yielding 4+% at the beginning of this past autumn's collapse in equity prices, the "flight-to-quality" made some financial sense.

Buying 30-Year Treasury bonds yielding 2 1/2% is not a "flight-to-quality"; it's a flight to stupidity.

Friday, December 26, 2008

Bond Basics

All blog entries at Rotten Investments are subject to our DISCLAIMER.

Mention Treasury bonds to most people and they'll think of the EE savings bonds that you see people buy for newborns or for children for their birthdays and other special occasions. EE savings bonds are issued at a discount to face value and earn a fixed rate of return for the life of the bond.

The 30 Year Treasury bond bears little similarity to a savings bond, except for the Federal government-backed guarantee. The 30 Year Treasury bond gets issued with a fixed coupon, with interest paid in two installments each year, but can not be redeemed prior to its maturity date. Only at maturity does the investor receive the face value of the bond.

While 30 Year Treasury bonds are not redeemable, they are transferrable. There is a dealer market for bonds and investors can buy and sell bonds (and notes) of almost any length of duration. If you have an online discount brokerage account, you should be able to view a menu of offerings available for purchase. If you own Treasuries, your discount broker should be able to get you an offer for any bonds you wish to sell.

The value of the EE savings bond is known at any given time by the tables maintained by the Treasury department for anyone wishing to redeem their savings bonds. The value of the 30 Year Treasury bond, or any other Treasury bond or note, is driven solely by market forces. With the interest rate fixed upon issuance, the bond itself becomes more valuable or less valuable depending upon what interest rates are doing in the market-place. As market interest rates rise, the value of a fixed interest rate security falls. And as market interest rates decline, the value of the same security will increase.

Herein lies the risk, and potential reward, of investing in bonds. The 30 Year Treasury Bond that was issued back in May with a coupon of 4.5% is now worth nearly 140. (The Treasury strives to match coupon rates to the market so that bonds are prices near par... or 100... upon issuance.)

So a Treasury bond investor who bought the 30 Year Treasury bond back in May is currently sitting on a gain of nearly 40%. That's an awesome total return for a Treasury bond. Unfortunately, that kind of a return is attracting investors to Treasuries who don't understand the risks of buying and holding longer-term fixed-income securities. Because when rates do go back up again, and they will, Treasury bonds are going to get hammered.

Taking a short position against Treasuries is not without risk. There are a number of ways you can play this trade. You can short the 30 Year Treasury bond futures. You can buy puts (or short calls) on certain Treasury Bond ETF's. Options trade on the iShares Lehman 20+ Year Treasury Bond (root symbol: TLT). There are interest rate options that trade on the yield of the 30 Year Treasury Bond (root symbol: TYX). All of these possibilities have their own risk/reward profile. It's up to you how to take this position, should you decide to play along.

Wednesday, December 24, 2008


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In no event shall Rotten Investments, its owners and management, or any successor companies, be liable for any direct or indirect trading losses caused by any information available on this site.

Rotten Investments makes no representations or warranties regarding the material contained on this site.

You do your own due diligence before buying or selling any security or, in the case of inexperienced/unsophisticated investors, you will seek the advice of a qualified professional regarding your investments.

The management of Rotten Investments almost always holds a position in or against the securities profiled on the site. Management may report when a position is initiated or covered, but is under no obligation to do so.


This past summer, I was visiting a web-site that almost exclusively followed and reported about investment analyst opinions. As I was skimming the stories they covered, one of them stood out: "Rotten Investments Sink British Banks". And my first response was, "No WAY! There's an investment analyst firm called 'Rotten Investments'? Awesome."

As it turned out, the story was quoting an analyst firm with an unimaginatively boring name that had done a research report detailing a British bank that got hammered with their real estate-oriented portfolio. However, being a frequent visitor of the old "Stock Lemon" web-site, I had to appreciate how provocative an analyst site with a name like "Rotten Investments" could be. ("Stock Lemon" decided to get respectable and adopted the name "Citron Research".)

I don't intend to get "respectable". I write about rotten investments. As an investor, I am usually long some form of an index holding, either S&P 500 futures, broad-based index call option contracts, or index ETF's. It all depends on what I'm trying to accomplish and whether or not I feel compelled to use a little leverage if I think stocks, as an asset class, are relatively cheap. Against this backdrop of long index exposure, I take short positions in asset classes, sectors, and sometimes individual securities where I feel prices are irrational relative to the risk/reward potential I see in the security.

Short selling imposes a higher level of risk upon an investor than simply buying and holding a diversified portfolio of stocks. It's not for everyone. But even if you don't decide to short the securities discussed on this blog, you should at the very least consider avoiding the rotten investments discussed here.

Friday, December 19, 2008

The Latest Bubble...

I've got lots of work to do in terms of formatting this blog, writing up the background of "Rotten Investments", putting together a blanket disclaimer page, etc., but I wanted to at least kick out an observation of what is the most recent financial asset bubble to grace our markets.

The yield on the 30 year Treasury bond is now flirting with 2 1/2%. This is the BEST opportunity to short the Treasury bond I have ever encountered in my two+ decades of working in the securities industry. And I can't think of a time when I've seen such a great opportunity to take a short position in a security with such little down-side.

This bet may take a while to pay off. I don't know when the return to normalcy in our markets will materialize, but when it does, Treasuries on the far end of the yield curve will not be trading with yields of 2 1/2%. What we're seeing in this market right now is an incredible set-up for a fixed income crash, probably before the summer of 2009. And when it crashes this time, it will dwarf the bond market crash of 1994.

*Disclaimer: I am short 30 year Treasury bond futures.