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Five Things You Need to Know: Get Out Now!


There's nothing quite like an alarming magazine cover to set the market's tone for the new year.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

Get Out Now!

There's nothing quite like an alarming magazine cover headline to set the market's tone for the new year. Talk of a bubble in Treasuries has been making the rounds on Wall Street for a couple of months now, so nothing new there. Over the weekend, however, Barron's gave the Treasury bubble cover story status, "Get Out Now!"

The piece is full of sage-sounding, cautionary advice, such as this warning from from Mohamed El-Erian, chief investment officer of Pacific Investment Management Co.: "Get out of Treasuries. They are very, very expensive."

Presumably, PIMCO, which runs the world's largest bond fund, is just looking out for the little guy. And, hey, if bond prices do plummet from here, then maybe they'll be kind enough to stem the tide by stepping in and purchasing them at "less expensive" prices.

Of course, the chief risk to the Treasury market, at least according to the Barron's article, is "the potentially inflationary impact of both the Federal Reserve's super-accommodative monetary policy, which has dropped short rates close to zero, and the enormous looming fiscal stimulus from the federal government."

That does sound like one disastrously inflationary cocktail. But below is why it may take much longer to make that drink than many think:

It's About Real Interest Rates

Sure enough, when the 30-year Treasury yields a nominal return of just 2.82%, it would seem there is very little upside in owning Treasuries here. But this is a tale of "real" interest rates, not the nominal rate as it appears in magazine articles.

If we buy a one-year bond for $100 with a nominal interest rate of 2%, then at the end of the one-year holding period we'll get back $102. If the rate of inflation is 2%, however, then our $102 return reflects a "real" interest rate of 0%.

That's how inflation saps purchasing power. You began the year "investing" $100. Even though you received $102 back at the end of the year, however, the rate of inflation has simply put you in the break-even position because your $102 purchases the same amount of goods that $100 purchased at the beginning of the year.

Here's why understanding real interest rates is important, however. During a deflationary debt unwind nominal interest rates are virtually meaningless. If the rate of inflation is actually declining, then your real return is much higher.

Meanwhile, in the "real world," real interest rates remain impossibly high, infinitely high in some cases, all of which is simply a fancy way of saying credit is tight, and in some cases completely unavailable for consumers and businesses.

Credit Really Is Tight

Look, I'm not just making this stuff up. Credit really is tight. Today the Wall Street Journal ran a piece noting some things you may already have noticed: "Credit Card Companies Slash Credit Limits."

According to the Journal, about 20% of banks reduced credit limits on the existing credit cards of prime borrowers. Sixty-percent lower limits for nonprime borrowers.

The newspaper reported American Express (AXP), US Bancorp (USB), Washington Mutual and Wells Fargo (WFC) each indicated they would reduce cardholders' credit limits due to perceived risks such as high balances or late payments.

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No positions in stocks mentioned.

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