Is it Too Late to Bail on Government Bonds?


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I once had a family relative who was a big believer in U.S. government bonds (NYSEArca: TLH). It was his opinion that government bonds were always a safer bet relative to other assets. And for that reason, he believed an investment portfolio consisting of 100% U.S Treasuries (NYSEArca: IEF) was the way to go. Unfortunately, my relative is no longer alive but if he were, I wonder if he would agree that lending money to today's U.S. government is a safe bet.' 

Given the U.S. government's deteriorating financial situation is it wise to own government bonds (NYSEArca: TLT)? And if you still own government bonds directly or a broad bond fund (NYSEArca: AGG) is it too late to bail?

Public Disdain for U.S. Debt
Bill Gross, manager of the Pimco Total Return Fund (Nasdaq: PTTAX) has been one of today's most vocal critics of U.S. government bonds.

In a shot at the traditional view that investment portfolios should always have exposure to government debt, Gross said, 'Old-fashioned gilts and Treasury bonds may need to be exorcised' from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint.'

Gross explains that free handouts have gotten the government into a fine mess.

'To rebalance debt loads and re-equitize financial institutions that should have known better, central banks and policymakers are taking money from one class of asset holders and giving it to another. A low or negative real interest rate for an extended period of time' is the most devilish of all policy tools,' said Gross in written piece titled 'Devil's Bargain.'

Anyone that has followed Gross' suggestion to completely bail on U.S. Treasuries has watched them rise. Like many on Wall Street, Gross is a better philosopher than a market timer.

The Wolf and the Boy
What can be said of the Three-Musketeers - Standard & Poor's, Fitch Ratings and Moody's ( MCO )? Like the boy that cried wolf, the credit rating agencies are at it again. How many pre-warnings and pre-pre-warnings about a potential downgrade in the U.S. government's credit score are they going to give us?

The public has already stopped listening to this rating nonsense, probably going back to 2008.  Why has the Securities and Exchange Commission permitted these so-called independent agencies to be so accommodating with the U.S. government? Haven't raters created a double standard? Would credit raters, for example, cut the same sort of slack for other bond issues they rate? What about troubled municipalities (NYSEArca: MUB)? When their credit quality is in doubt, do they get dozens of warnings like the U.S government, or do they just get the rug pulled from beneath their feet with a cut?

For whatever it's worth, Standard & Poor's ( MHP ) is forecasting that national debt will rise to 84% of gross domestic product by 2013. Maybe they should stick to forecasting instead of rating bonds.

Another King Kong-sized Headache
The concern about the deteriorating credit quality of government debt is impacting another important element of the financial system - money market funds. How?

Money market funds (Nasdaq: TRSXX), which are sometimes referred to as 'cash,' are an important component to the financial system because they provide investors with a place to park cash. Money funds are regulated under the Investment Company Act of 1940 and are typically sold as a 'safe' place to invest cash because they are designed to keep a steady net asset value of $1 per share. How do they achieve this goal? By investing in commercial paper, U.S. Treasuries and other short-term financial instruments. 

The first U.S. money market fund was started in 1971 by Bruce R. Bent and Henry B. R. Brown. It was called the Reserve Fund and the idea was to provide investors with a cash management tool that would give them stability and liquidity. In subsequent years, other money market funds offered from banks and fund companies followed. 

Money market funds get themselves into trouble when they venture into riskier assets to squeeze out a higher yield. Trouble can also happen when money funds buy assets that a purportedly safe, like government bonds, but are camouflaged rubbish. Is another repeat run on money market funds just ahead? 

Although low interest rates have bought the U.S. government time to get its financial house in order, they're just as much of a mess today as they were before. Conventional wisdom says to immediately sell all U.S. Treasuries, but we've all seen the poor results conventional wisdom often delivers. 

ETFguide's August ETF newsletter handicaps the odds of a U.S. debt default - with a unobstructed look at history. It also highlights specific actionable strategies for investing with the government's debt crisis in view. We take a detour from the crowd mentality to put 100% of your investments in precious metals (NYSEArca: GLD), coins, baseball cards or the mattress. History proves that crowd behavior is dangerous to your financial health. Will this time be any different? Probably not.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs
Referenced Symbols: MCO , MHP

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