You're Crazy to Hold Government Bonds... Here's a Safer, Growing Yield
Interest-Rates / US Bonds Jul 07, 2010 - 11:25 AMBy: DailyWealth
Dan Ferris writes: Investors are scared.
During the week of June 23-June 30, the American Association of Individual Investors Survey indicated investors are much more fearful than usual. On average, 31% of individual investors are bearish. These days, 42% of investors are bearish. On average, 39% are bullish. Today, just 25% are bullish.
And what do investors buy when they get scared?
U.S. Treasury bonds. Yields on U.S. Treasury long bonds recently hit new lows, below 4%. Falling yields mean rising prices.
These investors are buying exactly what they should be selling. And fortunately for us, they're selling exactly what they should be buying. Before I get to that, though, here's what you need to understand...
Treasuries are the obligation of a government with tens of trillions of unfunded liabilities (including off-balance-sheet obligations like Social Security and Medicare). If the U.S. government were a company, the interest rate on its bonds would be 40%, not 4%.
Back in late 2008, when stocks were cheap and still falling, U.S. Treasury yields briefly went negative, as terrified investors sought the perceived safety of government-backed debt. In the November 2009 issue of my Extreme Value newsletter, I said that was "the blow-off top of a 26-year bull market" in Treasuries. I still think that's true.
Yes, Treasury yields could go negative again. I can't predict the precise path Treasury prices will take. But I don't believe it's possible to borrow more than you can possibly repay and still be a triple-A credit. Sooner or later, reality has to have a say in this. Uncle Sam isn't triple-A. He's triple-C.
I'm not speaking figuratively. I'm speaking literally. Treasuries ought to be rated triple-C. Here's the definition of the triple-A rating, as assigned by Egan-Jones Ratings:
An obligation rated 'AAA' has the highest rating assigned by Egan-Jones's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong.
Here's Egan-Jones' triple-C rating definition:
An obligation rated 'CCC' is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.
Is the U.S. government's capacity to repay debts "extremely strong," as in the triple-A definition? Or is it "dependent upon favorable business, financial, and economic conditions" to keep afloat, like in the triple-C definition?
Will Uncle Sam's financial condition improve soon... ever? Will economic conditions improve in the next few years? How about business conditions? Will government lower taxes, abolish the Fed, and remove trade and wage restrictions? Will unemployment rise or fall if government penalizes businesses with higher taxes?
The triple-C rating applies better than triple-A.
Having suggested the triple-C rating, I'm also suggesting Uncle Sam be placed on negative watch for a downgrade. He could wind up with a mere C rating.
The C rating definition says it can be used when "a bankruptcy petition has been filed or similar action taken, but payments on this obligation are being continued." Uncle Sam is still paying, but when he prints more money, he looks more bankrupt than solvent.
That's why I've been telling readers interested in income to consider World Dominating companies with fortress balance sheets like ExxonMobil, Wal-Mart, and Microsoft. Egan-Jones rates all these companies AA- or higher.
They generate much more cash than they need to run, unlike the U.S. government, which is running record deficits. These companies have no net debt. They pay dividends between 2.2% and 3.1% – less than Treasuries, but these payments will grow over time. Each of these companies has increased its dividends every year for at least the past seven years.
And right now, scared investors are selling these stocks and buying Treasuries. It's absurd, but it means each of the stocks I mentioned is at or near a record low valuation.
Treasury yields could easily go lower from here, but not because they deserve to. They're the doomed obligations of a bankrupt government. If you're looking for income, stick with World Dominating businesses that deserve their stellar credit ratings.
Good investing,
Dan
P.S. There are currently eight World Dominator stocks on the Extreme Value list. Due to the recent market decline, six of them are now in buying territory. Every week, in my Extreme Value update, I publish a complete list of those World Dominators currently in buying range. That list is now longer than it's been in three years. Click here to learn how to access it immediately.
The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.
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