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Two of the world's most well-known and successful strategists have big bets on U.S. Treasury bonds in 2013 – in opposite directions.

Ray Dalio, billionaire founder of the hedge fund Bridgewater Associates, predicted that the biggest money in 2013 will be made by shorting U.S. Treasuries. Former Merrill Lynch chief quantitative strategist Richard Bernstein listed a long position in U.S. long-term Treasuries – the most volatile segment of the bond market – as one of his top investment ideas for 2013. What gives?

Mr. Dalio's outlook is all-around grim. He believes that the U.S. Federal Reserve has done all it could to support asset prices and, with the effectiveness of each round of quantitative easing declining, will be more or less powerless to stop a U.S. economic slide. Pinned down to predict a time frame during a recent panel discussion, he projects a steep selloff in U.S. Treasury bonds and rising interest rates in late 2013.

For equity investors the danger in this scenario is that, because of the laws of discounted cash flow, rising bond yields decreases the value of all assets. Mr. Dalio notes that all investments involve a lump sum, upfront payment in exchange for a stream of cash flow – earnings, dividends or coupon payments. The value of this stream of cash flow is determined by interest rates.

The calculation of discounted cash flow, using this handy online calculator, shows the importance of interest rates in equity valuation. For example, assuming an annual 10 per cent earnings growth rate, a $100 investment paying $2.50 a year for five years is worth 221.71 at current rates. But if rates rise to 3 per cent, inflation erodes the value of the futures earnings and the value falls to $131.06.

Mr. Bernstein's outlook shows far more faith in the Fed. He notes that investor risk aversion has pushed most bond investor assets into short-term bonds, which has historically been the lower risk strategy relative to longer-term issues. For Mr. Bernstein, the vast amounts of money being pumped in to the U.S. economy by the Fed will be enough to keep bond prices high and interest rates low. As bond markets become more comfortable with the environment, investments will gravitate to the more volatile longer-term bonds, pushing bond prices higher.

It is uncomfortable to side against Mr. Dalio, who predicted both the financial crisis and the 2009 market recovery, but we lean more towards Mr. Bernstein's view for 2013. In addition to the liquidity argument Mr. Bernstein cites, the income trust craze taught Canadians that investor lust for income can continue for far longer than previously thought. U.S. demographics, as the baby boomers retire, suggest a continued appetite for safe, yield-bearing instruments that should also support U.S. bond prices.

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