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.