Near-Zero Yields Are on Radar for a Treasury Bull Up 29% in 2020
(Bloomberg) -- The historic, pandemic-fueled surge in the U.S. government’s debt load is paving the way for years of middling economic growth, deflation and yields of all maturities near zero.
That’s the view of the managers of the Wasatch-Hoisington U.S. Treasury Fund, which has earned 29% in 2020 -- outpacing all its peers and rivaling some hedge funds -- by sticking to bets on the longest-maturity Treasuries as the coronavirus’s spread devastated economic activity.
Van Hoisington, the fund’s lead manager, and Lacy Hunt, the firm’s chief economist, didn’t flinch last month when 30-year yields at one point more than doubled from record lows. Instead, they grew more confident in their long-held view that the nation’s increasing dependence on borrowing will wind up impeding growth, after financing an initial sharp rebound from the current collapse.
At $17 trillion and counting, the U.S. debt burden is on a path to eclipse the size of the economy by an unprecedented degree, and already highly-leveraged companies are taking on more loans to stay afloat. That backdrop creates a world leaning too heavily on “unproductive debt” and less able to invest in technology and labor. Hunt expects it will take a half-decade or more to reduce the slack in the economy, an environment that makes very long-term Treasuries the best bet in fixed income.
“The U.S. had a debt overhang problem even before the coronavirus,” Hunt said. “It won’t be productive debt, and will not generate future growth. So inflationary expectations will turn into deflation expectations, and the entire yield curve is going to be pressed down on to the zero bound.”
The $451 million Wasatch-Hoisington U.S. Treasury Fund’s one-year return, at 49%, also puts it ahead of virtually all its rivals, according to data compiled by Bloomberg. It’s also beating the 40% increase in the Bloomberg Barclays U.S. Long Treasury index -- which includes debt with 10 years or more to maturity.
The fund holds fewer than 10 securities, consisting mainly of Treasuries due from 2040 to 2049. The portfolio includes standard Treasuries, but also several zero-coupon obligations called Strips maturing in about 20 to 25 years. These securities amount to one of the most bullish bets in the bond world.
Zero coupons have a higher duration than regular Treasuries, meaning that when yields fall they deliver a larger price gain. The fund’s duration is about 22 years, compared with about 6 for its benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index.
Of course, the opposite is also true: climbing yields will deliver outsize losses for investors with greater duration exposure. The fund lost 3.8% in 2018, while its benchmark was flat. Yields on the long bond rose 27 basis points that year, the most since 2013.
This year, the 30-year yield has dropped about 120 basis points to just under 1.2%. It plunged to a historic low of about 0.7% last month amid the market mayhem that ensued as investors grasped that the disease would effectively shutter the American economy.
While Hunt and Lacy have been bullish for years, the firm has backed away from the bond market when the U.S. faced accelerating inflation. For about a 45-month stretch in the 1980s, Hoisington was 100% in cash and cash equivalents to avoid a hit from rising yields.
“Van and I both lived through the inflation of the 1970s and that bear market and know how to position for that as well,” Hunt said. “We’ve been bullish now since the 1990s.”
For Hunt, the key to navigating the bond market lies in the Fisher Equation, which says the long-run Treasury yield is equal to the real rate plus the expected rate of inflation. Hunt says those two variables are headed lower. He sees the core personal consumption expenditure index of inflation falling over 4 percentage points from the current level of 1.8% by the time the economy bottoms out.
At Loomis Sayles & Co., Dan Fuss also sees a prolonged period of sub-par growth. He says he’s “very cautious” on corporate bonds given that many firms are laden with debt.
Fuss, who’s part of the teams that run the Loomis Sayles Bond Fund and Strategic Income Fund, last year moved about 35% of assets into a reserve -- invested in mostly Treasury bills and short-term notes.
“I wish I had placed it all, instead of just part of it, in long Treasuries,” said Fuss, the firm’s vice chairman. The funds’ strategic reserve is historically only about 3%.
“The economic recovery will be slow and gradual -- not unlike what followed the 2008-09 downturn and also similar to the extended recession of late 1957 that held until the early 1960s,” he said.
“Treasury yields could go quite a bit lower, and could -- not odds on, but could -- replicate the German experience of being negative.”
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