Treasury run-up won't last forever

by Allan Sloan, senior editor-at-large


FORTUNE -- Financial markets can make you look really foolish, even if you thought your analysis was right, and still do. Today's humbling example: the best investment by far for the first half of this year has been the one that people like me have been warning against: long-term U.S. Treasury bonds.

I've also said (and said) that you have to protect yourself against a decline in the value of the dollar because our need to borrow huge amounts to cover trade and budget deficits is eroding the greenback's standing as the world's reserve currency.

allan_sloan_2010c.03.jpg

But guess what? Even though it's been a crummy year for U.S. stocks, foreign stocks have performed considerably crummier.

Now, to the numbers, courtesy of Aronson + Johnson + Ortiz, a Philadelphia money management firm that tracks investment returns for 48 asset classes.

The only investment that showed a double-digit positive return for the first half of this year was ... long-term Treasury securities. Their total return -- price gains plus interest -- was 13.2%.

Meanwhile, non-U.S. stocks lost 12.2% (price declines and reinvested dividends) for the first half, while U.S. stocks lost 5.6%.

What's happening, of course, is that we're seeing a somewhat different version of the phenomenon in 2007-08, when scared investors sought refuge in the safe haven of U.S. Treasury securities because they feared a worldwide financial meltdown.

This year, it's the European problem -- Greece, Spain, Italy and much of the rest of the euro zone -- that's prompted investors to seek safety in Treasuries.

"When the world seems to be about to collapse and you want to stay liquid, the only viable trade is the U.S. dollar and Treasuries," says Brian Wenzinger, a principal at AJO.

What goes way up, must come down

All that money flooding into the Treasury market drove down the interest rate on long-term Treasury bonds. The rate on the index that AJO uses to measure Treasury performance fell to 3.68% as of June 30, the firm says, down from 4.45% at the end of 2009. That rate decline has driven up the bonds' prices, because a bond yielding 4.45% is worth more than face value when a new bond is yielding only 3.68%.

That difference -- $7.70 a year for each $1,000 of bonds for an extended period -- is worth a considerable amount of money. Hence, long-term Treasury bonds' strong performance for the first half of the year -- and our country's ability to finance its enormous deficits by selling Treasuries at very cheap rates.

When interest rates rise, however -- which they're sure to do, sooner or later -- the prices of existing bonds will decline. That's what happened last year, when the rate on bonds was up by almost 50%, to the aforementioned 4.45% from 2.97% at the end of 2008. Last year, long-term Treasuries had a total return of minus 12.9%, making them the biggest loser among the 48 AJO classes. The year before, in 2008, long Treasuries were among the best-performing asset classes.

How do I explain that my predictions have been so wrong for the past six months? Simply this. In the long run, markets are rational. In the short run, anything can happen. The tech stock and house price bubbles lasted far longer than rationalists expected them to, but they ultimately popped. So will the Treasury bond bubble. To top of page

Frontline troops push for solar energy
The U.S. Marines are testing renewable energy technologies like solar to reduce costs and casualties associated with fossil fuels. Play
25 Best Places to find rich singles
Looking for Mr. or Ms. Moneybags? Hunt down the perfect mate in these wealthy cities, which are brimming with unattached professionals. More
Fun festivals: Twins to mustard to pirates!
You'll see double in Twinsburg, Ohio, and Ketchup lovers should beware in Middleton, WI. Here's some of the best and strangest town festivals. Play
Company Price Change % Change
Bank of America Corp... 17.04 0.27 1.61%
Yahoo! Inc 42.08 -0.50 -1.19%
Apple Inc 101.79 0.21 0.21%
Microsoft Corp 46.68 0.16 0.34%
General Electric Co 26.21 0.16 0.61%
Data as of Sep 18
Index Last Change % Change
Dow 17,265.99 109.14 0.64%
Nasdaq 4,593.43 31.24 0.68%
S&P 500 2,011.36 9.79 0.49%
Treasuries 2.63 0.03 1.12%
Data as of 1:59am ET

Sections

Alibaba officially secured its place in history as the largest U.S.-listed IPO of all time. The company will be worth $168 billion. More

The Federal Reserve is probably not going to raise interest rates until the summer of 2015 at the earliest. More

Immigrant entrepreneurs leverage connections abroad to boost international exports -- and non-immigrants could stand to learn from their tactics. More

A 10,000 square-foot home doesn't take care of itself, and many of the uber wealthy families who own them don't want to tend to them either. So they hire people like Bryan Peele. Here are journal entries from a day in his life. More

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.