Hang On To Your Shorts

Those of you that fall victim to my occasional econ 101 soap box rants are aware of the preaching I have been doing with regards to the yield on treasuries. I have, for a long time, felt the yields on treasuries were far too low and unsustainable at current levels. This would indicate an opportunity to short said asset and capitalize when the yield (which moves inverse to the price) begins to rise.

Historically, the mechanical implementation of this plan would have been far too cumbersome (and expensive) for a petty investor to implement on their own. Luckily the boys at ProShares created a couple of new ETF's to fill this highly specific niche. Almost every etf and ishare available is built to respond to price changes in a certain index (in this case the Lehman 7-10 year treasury index). Some funds prosper when the index price increases, some prosper when the index price declines. The latter is known as a short play. Some funds use leverage (loans) to add some 'ultra' price movement, which simply means that the fund will move $2 for every $1 the underlying index moves (positive or negative). The fund that I had been tracking and have now purchased is both a short play as well as a leveraged 'ultra' fund. The fund is ticker symbol PST and is appropriately named the ProShares Ultra Short Lehman 7-10 Year Treasury.

Here is some high level reasoning for this play and the timing of it. It seems like everyone these days tracks the Fed's monetary policy and their actions related to the fed funds rate. The fed has pushed the current rate down to 2% which is a historically low level not seen since December 2004. The lowering of this rate increases money supply and is intended to 'heat up' the economy. The downside is that it fuels inflation. I recently compared the historical spread between true (core + non-core) inflation and yields on the 10 year treasury. The current yield on a 10 year treasury is within a few basis points of 4%, current inflation 4.18%. At no point in the last 20 years of our financial markets has inflation out paced the yield on the 10 year. In fact, just a short ten years ago you would have been rewarded with a 4% spread over inflation by purchasing the 10 year note. Now, while a 4% spread may be a bit lofty for an investment that is void of credit risk, the point remains that the current yield on the ten year isn't outpacing inflation and therefore something will have to give. Either inflation will have to settle, or the yield on the 10 year will have to come up. The fed has stated that they are seriously ready to fight inflation....they would most likely do this with an increase to the feds funds rate. That move would knock inflation down and raise yields on the 10 year. Both of which are good for my latest buy.

Now, if Starbucks could find its way to $18 a share I might just about survive this latest market correction without having to pledge any unborn children.....that's a whole other can of worms....