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Saturday, August 28, 2010

James Grant: There is No "New Normal" and Treasury Bonds are "Not Super Safe" - Rather, They are "Return Free Risk"

We said we'd come back with follow-up on our post about the flight to bonds from stocks: Forget it... Stocks are Worthless! Honey, We're Moving Everything to Bonds. We will respond in two parts, here and again in a future post.

Today, we share an excellent video and commentary from James Grant on Consuelo Mack WealthTrack. The video was broadcast on 6/11/10, but originally recorded in October 2009. He covers many topics, from treasuries, government debt, and central bankers, to gold, economic cycles, forecasting, value investing, and the potential China bubble. The discussion remains highly relevant today.

A few key points:
  • mood swings - "people overdue it on upside and especially on downside."
  • the "new normal" - tired of hearing about "the new normal" on TV and in other media? Mr. Grant correctly emphasizes: "there isn't any 'new'! It's always cycle after cycle, you go from extreme to extreme."
  • "zippy recovery"* - 2010E GDP consensus estimate was +2.5% (October 2009), "I think it'll be faster than that, at least for a couple of quarters."
  • advice from Graham and Dodd - "can't know future, therefore seek margin of safety."
  • "in investments in present.... can't know what will happen in 2010 let alone 2017, but can observe two things: opportunities in front of us as now priced; and, how the world is positioning itself for an expected outcome."
*BEFORE WE GET TO BONDS, one note: his "zippy" GDP forecast for 2010 remains subject to debate given recent economic data. Here is some text from Federal Reserve Chairman Ben Bernanke's speech yesterday (we include an embedded link to our prior post on whether jobs typically lead or lag recoveries - they always lag):
  • "Notwithstanding some important steps forward [in the economy], however, as we return once again to Jackson Hole I think we would all agree that, for much of the world, the task of economic recovery and repair remains far from complete. In many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow and joblessness remains too high. Financial conditions are generally much improved, but bank credit remains tight; moreover, much of the work of implementing financial reform lies ahead of us. Managing fiscal deficits and debt is a daunting challenge for many countries, and imbalances in global trade and current accounts remain a persistent problem."
Interestingly, global shipping/trade keeps improving, even in the United States - from the Journal of Commerce on Thursday:

Intermodal Hits New 2010 High
Major U.S. railroads set a new 2010 peak for intermodal shipments in the week ending Aug. 21, the second straight week of new highs in container and trailer loadings.

Truck Tonnage Climbs 7.4 Percent in July
Truck tonnage rose 7.4 percent in July, the eighth consecutive month of year-to-year increase, the American Trucking Associations reported.

Short Lines See Traffic on Rise
North American short line and regional railroads report freight traffic gains on the rise since mid-summer, in contrast to the wave of weak economic reports on housing and other activity for July.

Of course, mainstream media isn't currently focused on such positive news. Time will tell what truly comes ahead. It's possible that consumption will remain muted as we crawl out from under our debts. At the same time, the net exports component of GDP may remain overwhelmed by America's still insatiable consumption habits (even if somewhat weaker than in boom times) that pull in massive imports even as exports continue to recover (e.g. areas of export strength: technology, agriculture, industrial). For reference, here's how GDP is calculated from Wikipedia and our How's the Economy Doing update from June. Overall, we think we chug along.

But, there are many topics wrapped into bits of economic commentary. Let's return to Mr. Grant.

FINALLY, regarding bonds and the view that "treasuries are risk free assets," he says:
  • "treasuries are risk less or risk full at a price"
  • "As the WSJ used to say, 'every single day except Sunday, the WSJ would talk about supersafe treasuries."
  • "They're not super safe - as a friend of mine said, they are 'return free risk'. Or, more charitably, they are an option on a certain macroeconomic outcome, which is perhaps falling prices and dodgy business environment. that's where they would do well at current levels, and we might have that outcome. but they are a speculation on that outcome as opposed to an investment with a margin of safety. so, ppl fly to risk or to assets that are priced for a certain outcome. and that outcome is plausible or not and the assets are risky or not, but these assets are not inherently safe or inherently unsafe."
Here's the video - enjoy:
  • Why the dollar, gold and the ballooning federal deficit are critical issues for investors. Consuelo sits down for a rare one-on-one interview with contrarian market observer and historian James Grant, publisher of the influential newsletter, Grant’s Interest Rate Observer.

So, there you have it. Things aren't entirely satisfactory on the home front, we know, thanks to years of excess due to easy liquidity and human nature that always tends toward extremes (we agree with Mr. Grant). BUT, we think there are far better options than Treasury bonds and believe Mr. Grant and his friend are spot on about "return free risk." After all, what happens if government debts and deficits are really the problem everyone currently fears and there's no way out of our current predicament? Imagine this scenario: debt loads get even worse, foreign buyers stop buying our bonds, and rating agencies downgrade United States debt, signaling some slight risk of default (rather than "risk free" AAA). What happens in this scenario? Treasury rates move higher and bond prices move lower.

We'd much rather own dividend paying equities with sound balance sheets offered by "the Market" at attractive prices. We'll come back with more.

Happy investing,

Jeffrey Walkenhorst

Disclosure: n/a.
© 2010 Jeffrey Walkenhorst
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