Investors have been trained to think that U.S. Treasuries are an unsafe investment.
Trust me, I understand the bearish case for government bonds. I thought Treasuries should be avoided at all costs in late 2012 and early 2013.
Remember, the U.S. 10-year rate hit a multi-decade low of 1.4% in July 2012.
But the world is a much different place. Rates have risen and the euphoria surrounding government bonds has turned into pessimism.
With the Janet Yellen-led Federal Reserve tapering monthly asset purchases (quantitative easing), there’s a lot of uncertainty as to what the future holds in store for Treasuries.
Instead, investors are turning to bonds with credit risk – something that we discussed back in January.
Since then, a host of fixed-income portfolio managers have agreed with our view that high-yield bonds no longer provide sufficient returns for their inherent risk. Heck, Bloomberg seemed to like our “junk bond bonanza” idea enough to use it in the lead-in to a recent article!
Even with our stern warning, however, investors still love investment-grade and high-yield bonds… and they’re avoiding Treasuries.
If you’re one of them, here are my top seven reasons why Treasuries should be embraced, not shunned…
Reason #1: Treasuries Are Currently Attractive Relative to Global Bonds
First, it’s important to understand that Treasuries are yielding more than government bonds of many other developed countries.
Inflation is the enemy of bondholders. We have to make sure that we’re being sufficiently compensated, given an erosion of purchasing power over time. Treasuries offer the highest real rate of return based on 10-year rates and the year-over-year change in the Consumer Price Index (CPI).
Granted, inflation isn’t going to remain constant in these countries, but this table gives us a good snapshot of the relative value of various government bonds.
Over the past century, the U.S. dollar has lost about half of its purchasing power every 25 years through inflation. Even though the rate of inflation has slowed recently, this is one of the reasons why we want to stick with 10-year U.S. Treasuries (T-Notes) and not invest in 30-year U.S. Treasuries (T-Bonds).
Now let’s take a look at how attractive T-Notes are relative to German government bonds (Bunds).
As you can see, the yield on Treasuries is once again at an attractive premium to this important European benchmark rate.
Reason #2: The U.S. Dollar Will Be Fine… for the Time Being
Government bonds are closely linked to the currency of issue, so let’s take a closer look at the U.S. dollar.
As a consistently profitable foreign exchange trader, I’m often puzzled – and amused – that so many investors continually think the dollar is doomed.
The dollar may be flawed, but so is every major currency in the world.
Consider that the trade-weighted U.S. dollar index has risen over the past three years. That’s right… the dollar has gained against its largest peers.
And it’s gained even more against some emerging market currencies. We’ve all seen the movie Slumdog Millionaire. Jamal Malik won 20 million rupees, the equivalent of around $450,000 at the time the movie was supposed to have taken place. If he had kept his winnings in Indian rupees until now, he’d only have around $325,000 today.
Indeed, instead of worrying about the dollar collapsing, over the long term, we should be far more worried about other currencies.
The Japanese yen is a perfect example. The U.S. government’s debt problems pale in comparison to those of Japan. Plus, Japan would kill for the United States’ new-found energy resources and skyrocketing gasoline exports.
Reason #3: Treasuries Have a Place in Our Diversified Portfolios (Alongside Dividend Stocks)
Dividend growth stocks should be the foundation of any portfolio. But it’s not prudent to have a 100% allocation to equities, especially if you are close to, or in, retirement.
We can’t predict the future. That’s why our portfolios need to be diversified. This also allows us to grow our wealth no matter how the market environment changes.
Along these lines, I’ve tried to share a variety of income investment ideas, ranging from the 8% yielding DoubleLine Income Solutions Fund (DSL), to gold and silver miners with shareholder-friendly dividend policies.
Treasuries are another piece of this investment puzzle, and they currently should have a place in your portfolio. In fact, Treasuries are actually the perfect complement to higher-yielding foreign stocks. Just make sure you leave the 30-year Treasuries to the pension funds and professional traders.
Now, I’ve given you three great reasons why you shouldn’t be scared of Treasuries. But I’ve saved the best for last.
Next week, I’ll cover the most compelling reasons to buy U.S. Treasuries, as well as how we can limit the risk of losses due to rising rates.
Safe (and high-yield) investing,
Alan Gula, CFA