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I Shorted the United States Treasury Market (And You Should, Too)

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Are we about to witness a final blow-off top to Treasuries, sending them below their post World War II record low?

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Get out when the market lets you out.
--Paul Tudor Jones
There is a large reallocation trade coming to the surface, a rotation that will take the investment community out of bonds and back into stocks. The key ingredient to this equation is timing. Are we about to witness a final blow-off top to Treasuries, sending them below their post World War II record low? A final market meltdown? The things we fear are probably feared by others, and when we avoid them, we're doing what others are doing as well. This is why theres a scarcity of whatever work it is we're avoiding. And, of course, scarcity often creates value. The shortcut is simple: If you're afraid of something, of putting yourself out there, that's a clue that you're on the right track.
We're at an important inflection point, and the noticeable divergences should be used as a warning. According to Bespoke.com, "following last fall's strong surge, the US Long Bond Future has practically flat-lined. Over the last four months, the spread between the intra-day high and low has shrunk to 4.6%. Last October, the high/low range was more than 20%, and even before the big move, the four-month high/low range was above 8%." Was this surge the tipping point to a top in the bond market? Since last October, US Treasury yields have been in a bottoming process. Such events manifest over a function of time.



The 30-year bull market that began in 1982 in US Treasuries is coming to an end. Since the financial crisis began in 2008, investors have flocked to non-paying yield assets for safety and protection against principal loss, evidenced by their four-year annualized return of 15.62%. In early February I highlighted this dynamic stating: "From 2007-2011 retail investors sold $450 billion domestic equity funds and purchased $930 billion bond funds, a startling $1.4 trillion difference. The long-awaited reallocation out of fixed income investments will begin to take form and provide a rotation back into the stock market; historically the stock market peaks with the 10-year US Treasury yielding 4%." The truth we must keep at the forefront of our focus is that the crowd is prone to believing that an increase in interest rates is good for stocks. While in the early innings, rising rates tend to lend a helping hand to the stock market, over time, rising inflation is a significant head wind to both the market and the broader economy.
The other fundamental argument for shorting Treasuries is the likely rise in nominal interests rates. Significant increases in the money supply supports inflation and inflation leads to a sharp rise in interest rates. Since President Obama's inauguration in 2009, the US national debt has increased by $5 trillion. Additionally, the Federal Reserve has increased the size of its balance sheet by $2 trillion. Factor in global quantitative easing and $12 trillion in new money has been created from global central banks' printing currencies. Rising inflation is the greatest threat to America in the coming years. This is precisely what gold, along with the bond market, has been telling us with its rapid ascent in price.


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Crude oil is a commodity latecomer to keep an eye on. According to Bloomberg, since October of 2011, the increase in gas prices has resulted in an extra hit to consumers' wallets to the tune of $56.0 billion. As crude oil approaches its seasonality uptrend there will be a substantial increase in consumer spending dedicated to and hamstrung by higher gas prices. If oil prices were to rise roughly $20 per barrel from the current $105-per-barrel level to $125 per barrel, it would wipe out 0.4% of GDP growth.
The elephant in the room is the United States Treasury, which must float an unsustainable amount of debt. Recall the United States Federal Reserve is sitting on a balance sheet that looks to be a financial institution in drag. It's within its best interest to keep rates at depressed levels in order to finance its debt payments. A surge in interest rates, coupled with a rise in real inflation and a stock market that appears to be headed toward all-time highs sets the stage for a liquidity event that few are focused on. The pieces to the investment puzzle are moving, and we may be in for a few surprises before they fall into place. The one worry that keeps my eyes open at night is the suspicion that investors may have one final opportunity to play Warren Buffett and throw darts at their favorite stocks, but only if the tide pulls back on this strange ride we are on.
Position in TBT

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