John Hussman looks at the interest-rate risks inherent in buying long-term government debt.
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John Hussman on Risk Vs. Reward for 30-Year Treasuries
Ryan Leggio: Jeff Gundlach, the president of DoubleLine Funds and the manager of DoubleLine Total Return. He is the former manager of TCW Total Return, gave a keynote address at the Morningstar Investment Conference last week in which he recommended investors purchase long-term treasuries, specifically because of the deflationary concerns out there, because of the relatively steep yield curve and his recommendation was long-term treasuries are the place to be but if investor confidence in the United States government wanes, to get out very, very quickly.
The reason why he had to qualify his remarks and say to get out quickly was because of the math of long-term treasuries. As you and I both noted, the long-term 30-year Treasury is about 4% annualized right now. The problem with that is the duration of 30- year Treasury Bond is, approximately 15 years.
John Hussman: The benchmark is closer to 17 right now.
Ryan Leggio: So, 17.
John Hussman: The yield has come down and durations blow out when yields come down exactly.
Ryan Leggio: So, 17 years. So, if investors really time that poorly, they are in a world of hurt because that capital loss will more than overcome the income return. Do you have any specific comments about that investment strategy, especially since both you and Jeff Gundlach both think there are deflationary issues over the next few years for the U.S. economy?
John Hussman: I do think that there are those issues. The question becomes, “How much risk do you want to take for a given amount of expected return?” As we just went over, if you are looking at 15-year to 17- year duration on a 30-year bond, really what that means is that if interest rates move by a 100 basis points, the bond price moves by about 17% up or down. So, you're really looking at a lot of sensitivity.
We actually saw a similar situation back in the beginning, actually at the end of '08, where we got 10-year yields down to just about 2%. It was fascinating and the 30-year bond was really down to low-yield as well. And my concern was it’s very quick, 30-year bonds could give up 25%, 30% of value and in fact they did because we got down to such a low yield that any yield movement at all had to be on the downside or investors would be hurt.
And so, my suggestion here is for investors to actually be very tolerant, very aware of the amount of risk that they can tolerate because it's not at all clear to me that we're going to see any letup in the amount of debt that the Treasury has to issue if not for bailouts, which I hope they don't, at least for unemployment compensation most likely for stimulus plans, which again, I have mixed feelings about and so forth. But normally after credit crisis as Reinhart and Rogoff note in their book, This Time is Different. Domestic debt tends to go up by about 86% over the three years following a credit crisis. So, we are going to see a lot more Treasury issuance probably.
I am hesitant about the idea. We'll speculate on something that's very risky until you shouldn't and as soon as you shouldn't, get out. My experience has been that investors don't get the chance to all get out at the same time and for our part, we prefer to panic before everybody else does. That's one of the things we've constantly said. We tend to be early but we prefer to panic before everyone else does and that served us well. I think the same is true of investing in 30 years.
You really have to know your risk tolerance otherwise. For our parts, I think 10-year Treasury securities are fine as a portion of a portfolio with the understanding, as you mentioned Ryan, that if interest rates turn, those things lose in proportion to their duration. So, you don't want to have a lot of duration risk as we move further through any economic downturn or crisis. You would tend to want to move to shorter maturities even though those maturities invariably will be providing you next to no yield because it's just safer and it's better to have your money in something safe that doesn't have a lot of capital loss than to have something in something risky where you could actually lose a lot if interest rates turn.
Ryan Leggio: So John, it really sounds like bond investors and stock investors really need to be not only resilient but really need to keep an eye on market conditions over the next few years.
John Hussman: Sure.
Ryan Leggio: John, thanks so much for joining us today.
John Hussman: It's a great pleasure as usual.
Ryan Leggio: Thank you for joining us. This is Ryan Leggio for Morningstar.