With most of the investment world feeling giddy about the prospects for the stock market in 2011, let's spend a moment these holidays exploring an alternative view of what the coming year could hold.
According to this perspective, the most tantalizing stocking stuffer isn't a grab bag of equities, but something far more boring - the 30-year U.S. Treasury bond.
"One of the best opportunities we see right now is the very long end of the bond market," says Murray Belzberg, president of Perennial Asset Management Corp. in Toronto. He's so convinced of the merits of the long-dated U.S. Treasury that he's devoting 25 per cent of his company's fixed-income portfolio and 30 per cent of its equity portfolio to the investment.
Mr. Belzberg twigged to the long bond's appeal when he and his team began examining the probable effects of the United States' current round of quantitative easing - so-called QE2. Like most people, they initially assumed that the U.S. Federal Reserve's plan to pour hundreds of billions of newly created dollars into the economy would lead to higher inflation, which is bad for bonds.
They discovered, though, that history doesn't support those fears. The first round of quantitative easing in the United States in 2008 and 2009 didn't result in an outbreak of inflation. Neither did Japan's quantitative easing earlier this decade.
In fact, the effects of quantitative easing appear to be distinctly temporary. "Our view is that QE2 is not going to have much success," says Mr. Belzberg, who thinks that yields on the 30-year bond may quickly fall back by a percentage point, retreating to their levels before QE2 was first hinted at in late August.
If that does happen, those who purchase the long bond at its current price will make about 19 per cent on their investment, because bond prices move inversely to bond yields.
Long-bond holders will do better than most stock market investors over the coming year, in Mr. Belzberg's view. "Equity markets have been very strong over the past few months," he says. "But our view is that the economy isn't going to be great. We don't see what would drive stocks higher from here."
It should be emphasized that this is a minority view. Most polls indicate investors are wildly bullish on stocks and down on bonds. Surveys conducted by the National Association of Active Investment Managers and the American Association of Individual Investors are ebullient about what lies ahead for stocks in 2011.
The only problem is that these surveys have been mediocre predictors in the past. As an analysis on the Seeking Alpha website points out, optimism about the outlook for stocks was also running amok in 2006 and 2007. In 2006, the optimists were correct; in 2007, they were wrong.
In the longer run, many economists and analysts believe that quantitative easing as well as the runup in government debt will inevitably lead to an era of rising prices. John Hussman, president of Hussman Econometrics Advisors, thinks any signs of economic recovery will lead to runaway U.S. inflation in the second half of this decade.
The opposite point of view is provided by Gary Shilling, a long-time bond bull. He argues in his new book, The Age of Deleveraging, that the United States is set for a prolonged period of slow growth and moderate deflation as house prices decline another 20 per cent and consumers shed debt and save more.
Over the past few weeks, Treasuries have plunged in price and yields have shot up to around 4.5 per cent, reflecting the general rise in optimism about the prospects for recovery in the United States. So anyone who invests in this area should be aware that they're running against the trend. If yields on the 30-year bond were to rise by a percentage point, investors would be looking at a double-digit capital loss.
But to those looking for a contrarian investment - and let me say that a small portion of my portfolio is invested in the long end of the U.S. bond market through an iShares ETF - the 30-year Treasury holds appeal.
Mr. Belzberg, for one, doesn't think that it will take long for long-bond yields to retrace their recent gains and reward owners of the 30-year Treasury. He has no objection to holding the bonds for a year or two if need be, but he thinks the rewards will come sooner than that. That may not be the majority opinion, but in the current environment, it's one well worth pondering.
Ian McGugan