Investors Turning Their Back on Treasury Issues

A three-year rally in U.S. Treasury securities may have ended Oct. 9, the same day the Standard & Poor’s 500 stock index fell to its lowest level since 1997, some investors say.

Since then, the S&P; 500 has risen 20.5%, while the benchmark 10-year Treasury note has dropped about 4.4% in value.

The Treasury note’s yield has climbed from a 44-year low of 3.57% on Oct. 9 to 4.21% as of Friday. A bond’s yield moves inversely to its price.

“The days of capital appreciation for U.S. Treasuries are probably over,” said Bill Gross, manager of Newport Beach-based Pacific Investment Management Co.’s Total Return Fund, the world’s biggest bond fund, with $64.5 billion in assets.

More investors are betting on an economic recovery in 2003 and are seeking higher returns in stocks and corporate bonds.

Consumer confidence and retail sales indexes rose in November, fueling optimism that corporate profits overall will pick up.

“Given the strength in consumer spending, and the rebound in stocks, would you lock up your money for the next 30 years” at current Treasury yields? asked Kurt Harrison, co-head of government bond trading at Banc of America Securities.

Those betting that Treasury yields will continue falling and that bond prices will keep rising are fighting history.

For the first time since 1939 to 1941, Treasuries are on track to outpace stocks for three consecutive years, according to Chicago-based research firm Ibbotson Associates.

But not since an even darker period in U.S. economic history -- the years 1929 through 1933 -- have government bonds fared better than stocks for four years in a row.

Instead of government bonds, more income-seeking institutional investors now are turning to higher-yielding corporate issues.

Buyers snapped up more than $44 billion of bonds in November from companies such as Kraft Foods Inc. and IBM Corp.

The demand has helped bring down the “risk premium,” the difference in yields between corporate bonds and Treasuries. Even as Treasury yields have risen, the yield on an index of 100 corporate “junk” bonds has tumbled to 10.60% as of Friday from 12.34% on Oct. 10, according to KDP Investment Advisors.

But the spread still makes corporate issues more appealing, many investors say.

“There’s been a huge change in investor psychology to once again take risk,” said David Brownlee, who is adding corporate bonds to the $7 billion he oversees at National Life Investment Management in Montpelier, Vt. “There’s no yield in the Treasury market anymore.”

The prospect of war with Iraq may keep investors from parting with Treasury holdings too quickly, economists said. But “once the war is over, more people will feel confident,” said Stephen Stanley, an economist at RBS Greenwich Capital in Greenwich, Conn.

Of course, many analysts have foreseen an end to the Treasury bond rally before, only to be proved wrong.

For example, investors dumped Treasuries on April 1, sending the 10-year note’s yield to a 10-month high, after a bigger-than-expected gain in a manufacturing index provoked concern that the Federal Reserve would start raising interest rates for the first time since May 2000.

But that was a false alarm, as the economy lost more steam in spring.

This time, however, Treasury bond investors are facing increasing amounts of supply, which will weigh on prices of existing securities, as a widening federal budget deficit causes the government to sell more debt.

The Treasury last month sold $40 billion in five- and 10-year notes at its quarterly auctions.

The government recorded a $54-billion budget deficit for October. An increasing number of economists predict that the deficit will rise to $200 billion or more in 2003, according to a Bloomberg News survey.

“It will be easier to pass a fiscal stimulus bill now that the president and the majority of Congress are on the same side of the aisle,” said Sadakichi Robbins, head of fixed-income trading at Bank Julius Baer. “The government will have to issue more debt.”

Meanwhile, many analysts believe the Fed has done all it can to help the economy. The central bank cut its benchmark short-term interest rate to a 41-year low of 1.25% on Nov. 6.

“The end of a bond rally occurs when the price of money can’t be lowered any more,” said Pimco’s Gross. “The anchor, of course, is the Fed.”