GOVZ: Now Might Be The Worst Time To Go Long, Long Bonds

seekingalpha2023-12-28

iShares 25+ Year Treasury STRIPS Bond ETF provides exposure to the principal portion of Treasury STRIPS.It is a passive ETF that has tracked its index impressively.We review the fund and tell you why ...

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STRIPS in its expanded form is \"Separate Trading of Registered Interest and Principal of Securities\". Breaking it down further, STRIPS are created by separating all of the periodic coupon payments, as well as the principal repayment of U.S. Treasury Bonds and selling them to investors as zero coupon or discount bonds. The maturity dates coincide with the periodic coupon and the principal repayment dates of the original bond. The following illustration provides a good overview of the process. efinancemanagement.com Coming back to GOVZ, this ETF specifically provides exposure to the principal portion of the STRIPS (think \"Bond 11\" in the example above). With 25+ years to maturity and discount bond holdings, GOVZ is primarily a bet on duration, rather than a lean and mean income generating machine. GOVZ is passive, which means that it simply tracks an index that comprises its target STRIPS. The name of this fund's benchmark is ICE BofA Long US Treasury Principal STRIPS Index and GOVZ uses representative sampling to select securities for its portfolio. At least 80% of the fund's assets are picked directly from the index incumbents and 90% of the fund's assets are comprised of securities that the advisor believes will assist GOVZ in tracking the index. So that means, a few securities in the GOVZ portfolio may not be from the index, but are selected because of the similarity in investment and fundamental characteristics. Since its mostly the index versus the advisor steering this ship, the fund has modest annual expenses. GOVZ The index, unlike the fund, does not have any expenses, which makes its performance versus the index impressive. This ETF began operating in September 2020 and has outperformed the index over every timeframe, save the one. GOVZ Neither have managed positive returns, however. This is not surprising as interest rates have not been kind to the long duration securities for a chunk of this timeframe. Data by YCharts From peak to trough, the price of GOVZ fell around 35%, which puts the risks which come with long duration into perspective. A 27-year effective duration brings with it a risk that the fund portfolio value declines by 27% with every 100 basis points rise in rates. GOVZ Vice Versa also applies, which is why, with the Federal Reserve signaling the end of rate hikes, the GOVZ has started to recover in price. This ETF distributes on a monthly basis, with the last one being 4.08 cents. GOVZ With the fund trading at around $12.21, investors get an annual yield of 4.07%. Outlook The big question investors have today is whether the long term bonds should be bought hand over fist. We had discussed this in our coverage of US Treasury 3 Month Bill ETF (TBIL) back in August, by laying out a long term study that helped investors know if the time is right. We revisit that today by reproducing the chart from what was presented in that piece. Hussman Strategic Advisors This chart lays out the components that when considered in tandem, can signal whether hand over fisting may not be a bad idea. 1) 3 Month T-Bills (Weighted at 50%). 2) 12 month Core CPI (Weighted at 25%) 3) 12 Nominal GDP (Weighted at 25%). The signal to go ahead is when the long term bonds yield 5% higher than the weighted average of the trio. We start off by updating the three with the current numbers, because the chart presented above is a bit stale. 1) 3 Month T-Bills at 5.25% 3) Trailing 12-Month Core CPI at 4.00% 3) Trailing 12-Month Nominal GDP at 6.3% The resultant weighted average is 5.2%, and the long term bonds yield is not in this ballpark even. Data by YCharts Barring early 2020 (start of pandemic), following this methodology has worked beautifully for determining the buy case for long bonds. H8ussman Strategic Advisors So, in summary, we are not there yet. Verdict on GOVZ The Federal Reserve has convinced the vast majority of global investors that rate cuts are coming. Bank of America The \"net 43%\" above is the difference between those expecting lower rates and those expecting higher rates. The ones that don't have an opinion or are expecting unchanged rates, have been left out of the calculations. Whichever way you slice it, that is one of the most extreme numbers you could see in this survey. The result? Rate cuts have been priced into long term bonds. The chart also forces us to face another important fact. The two other times the expectations were this high (2006 and 2009), buying bonds was a very poor decision over the next 12 months. We did not have GOVZ in 2009, so we have shown Vanguard Extended Duration Trust (EDV) as an example. Data by YCharts Of course our current reading is figuratively off the charts. How this resolves remains to be seen. With $9 trillion in refinancing plus budget deficit needs in 2024, investors might be walking into a rough setup. Currently, there is just no upside to locking in long duration. Biding time by holding TBIL or iShares 0-3 Month Treasury Bond ETF (SGOV) makes sense for now for the Treasury portion of your bond portfolio.  Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. 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