LEON COOPERMAN: WHY US GOVERNMENT BONDS ARE THE “LEAST ATTRACTIVE” ASSET CLASS

Via Bloomberg TV:

Lee Cooperman, the billionaire chief executive officer of Omega Advisors Inc., spoke to Bloomberg TV’s Erik Schatzker this morning about his hedge fund’s investments. Cooperman said investing in U.S. Treasuries “makes no sense,” he considers stocks the best investment today and that he likes gold, the S&P and Apple.

On investing in Treasuries:

“I have great confidence the Fed is ultimately going to get their way. The Fed is trying to elevate asset prices, help consumption, help the economy and in two-three years time, we will be worrying about inflation and interest rates will be materially higher.”

“An instrument that I have absolutely no interest in – the most widely traded instrument in the world – is US government bonds. I don’t think people understand how risky a US government bond is at 2% return.”

“I understand the arguments of those that are liking it but a 2% government bond… if we’re  talking about marginal tax rates, all in state and local, federal 40%, you’re keeping 60% of your 2%, you are keeping 1.2% . The rate of inflation is somewhere in the range of 2-3% so your capital is being confiscated, it makes no sense.”

“If you look at the history of the 10-year government bond – normally, and we’re not in normal times now, we’re in a world of financial repression because of weak economic conditions – in normal times, a 10-year US bond yields in line with nominal GDP – nominal GDP is the summation of inflation plus real growth.”

“So if inflation is ranging 2-3%, let’s say and real growth is 2-3%,that would mean nominal GDP would be growing normally between 4-6%. So if I told you 10 year government bond was going to 4-5%, you wouldn’t think that was a bold or unusual forecast. Well, that is an enormous capital loss for the person that holds that 2% government bond.”

“Amongst the panoply of financial assets, I think US government bonds are the least attractive and I think equities, and I’ve been premature in all honesty, the market didn’t do as well as I thought it would do last year, it’s slightly ahead of schedule this year- but when I look at the alternative of financial assets – Cash earns zero, and Bernanke has promised us it is going to be zero for a couple of years; you’ve got keep some of that for security and safety purposes; you have U.S. government bonds at 2% – 0 interest and I don’t own ONE In my portfolio.”

“The third alternative is high yield, that’s had an enormous rally that’s down to a little over 7%; so selectively you could find individual issues that make sense, but collectively high yield has kind of got itself fully priced.”

“Then you’re left with the S&P, which is 13 ½ earnings; yields a bit over 2%, 10% below the historical multiple at a time when interest rates are below historical and you can find lots of cheap stocks out there that will yield more than bonds today that are good companies that will grow over time.”

“So I think by default stocks went out, and they are the best house in the financial asset neighborhood. Not to say we’re not without problems – Iran, the price of oil, the uncertainty over political outcome come November…”

On what equities he likes: 

“I think gold will work, I think the S&P will work, they’ve already worked somewhat this year. The S&P is up somewhere around 8%.”

“We find a lot of cheap stocks around, technology. I hate to buy things that are up a lot, so forgive me if I mention things that we own, but we own them and we would not own them if we didn’t like them.”
“I would like to put new money to things that haven’t moved.  We like, in technology, Apple and Qualcomm.”

On Apple’s share price and Apple vs. RIM: 

“We think [Apple] is worth something north of $600.”

“It’s funny, it was really like a mass hysteria. We put about a half of one percent  of our assets into RIM late last year on a theory that they had a revenue base that was being mispriced by the market. Which was 20% of what we had in Apple, we’ve owned Apple now for a long time, and we continue to own a big position, so we had five times more Apple investment than RIM.”

“We kept on getting calls from the press about RIM. We sold RIM because we have a discipline of taking stop losses, still think it might be intriguing. They have 75 million subscribers, that are paying them on average almost five dollars a month for the email service. We’re out of it.

“I wouldn’t say Apple is the leading candidate for new money, I wouldn’t put new money into Apple, but we’re riding the trend. And we think they have a unique position and a couple more years of very good runway ahead of them. ”

“Qualcomm has the dominant chip in smart phones.”

“In the financial area, we own JPM, a little bit of Citicorp, Bank of America, and a very unique company called Altisource Portfolio Solutions which helps manage the foreclosure process for banks.”

 

“In the healthcare area, we like the HMOs, the United, WellPoint, Boston Scientific. In the media area we like EchoStat, Dish. There’re just no shortage of attractive stocks.”

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • anon

    So basically “stocks are the winner by default”…

    Its a fairly typical view but I don’t agree with the logic – which is “well you gotta own something so you should own stocks”

    Having no position is a position. Cash doesn’t earn much, but it also carries no risk of capital loss in the shorter term

  • Nils

    If he’s running some kind of fund holding cash will not earn him money and will probably lead to redemptions. That allocation decision has to be made at another level.

  • Dan M.

    30 year treasuries looked like an AWFUL investment at 4.5% in 2008 with skyrocketing gas prices.

    30 year treasuries looked like an AWFUL investment at 4.5% in 2011 with CPI having risen 2.3% in the previous 6 months.

    30 year treasuries performed amazingly if people would have invested in those at the time…

    But since we’re not all market-timers, 30-year treasuries also do a WONDERFUL job of diversifying a stock-heavy portfolio… much better than shorter-duration or higher-risk (corporate, muni or junk) bonds, while still paying out decent (3.2%) interest… I realize decent is relative, but it’s higher than short-term corporates are paying today (2.4% abouts), and it’s state non-taxable to boot.

  • Larry

    The 22% rally from the Oct 3rd low has brought equities up from undervalued to fairly valued, and possibly a bit overvalued. A better question that Cooperman failed to ask is: what asset classes are undervalued now?
    Possibly corporate bonds are in the sweet spot in between risky equities and low-yielding treasuries. Also lower beta dividend paying stocks. But there is risk everywhere you look. As Gundlach wrote in Forbes: Pick your Poison.

  • wh10

    Cullen,

    If you could indulge me with a more technical perspective on investing.

    A favorite go-to of mine these days are the following points from Fullwiler:

    “First, there are these things called primary dealers, who can borrow at the repo rate and fix their costs for any maturity in forwards and buy any Tsy issue that goes above the borrowing costs. And the repo rate–created out of thin air with just a previously issued security as collateral–always arbitrages with the overnight target rate.

    Second, there are these things called hedge funds–like 100s of Warren Moslers–who can (and in the case of Mosler, have and will continue to) borrow at LIBOR and fix this rate at any maturity in swaps or forwards. And LIBOR arbitrages at the overnight target rate, while eurodollars are created out of thin air like any bank loan.”

    This suggests to me that there is a world of investors out there that don’t think like most people, including the hedge fund in this video. In other words, from this lens, it seems there is always a profit to be made on bonds such as these using derivatives to capture spreads which will ultimately be “arbitraged” away. It seems to be a different way of looking at bond investing as compared to someone, like this guy, who is seeking long term real-returns from a simple buy and hold strategy.

    Do you have any light to shed here?

  • Dan M.

    This is why I like to build my portfolio off of the foundation of the Harry Browne Permanent Portfolio… Domestic stocks, ST treasuries, LT treasuries, and gold, 25% each.

    It’s not perfect, but it gives you a great place to start off from. When I think it’s overextended itself, (as I think it has now) I pull back much more into the corporate bonds and dividend stocks you mention…. everything looks a bit spendy at this point.

  • http://www.google.com Alby

    This is the work of the Fed. In pushing down yields on Treasuries, the Fed is forcing everybody into equities (aka: Risk). It doesn’t want people parking money and waiting for a nice day. It wants money to flow into risk to spark the economy.

    Its a solid game plan, as long as Inflation doesn’t spark. That is the risk the Fed is playing. A game of chicken, in which its priming the market to force money into risk to get the economy going before its efforts are thwarted by the inflation is has put into the economy with its massive dollar printing.

    At which time, the gig is up. If inflation kicks in, the fed has to tighten, and thats when rates on everything will sky rocket. Bonds will be dumped enmass and little old days will be crying that their savings has been wiped out. While local Governments since the blues that building new schools is cost prohibitive with 8% yields on the 10yr.

    The next few months/years will be very interesting. And profitable for anybody shorting bonds.

  • Octavio Richetta

    The valuation model for stocks he is using clearly shows the biased nature of this guy’s views. Need to look at valuation based on smoothed earnings. You need to check out the D. Short/Cretmont research valuation models.

    I think he is wrong on both Rim and Apple. Rim’s network has lost its appeal since most people now have Internet plans in their phones. What worked for Rim in the way up (expanding user base) will work against them in the way down. How many people u know that have traded in their BB for an iPhone?

    On apple, people are not yet aware how important Steve Jobs was for this company. It is amazing how soon people forget. Let them go trough two or three new product cycles and you will see evidence of what I mean.

    On long treasuries, I own whatever the guys who manage the bond funds I own, PTTRX DBLTX AND TIIAACREF bond account, hold, but if long rates go up again on shaky grounds, I will back up the truck again on 30 year strips.

    But who I am to say? The guy is a billionaire and I am not:-)

  • http://www.pragcap.com Cullen Roche

    Well, I think the key to making money in US Tsys is to front-run the Fed and understand their communications with the market. It’s not about what they do, it’s about what they say. The Fed controls the curve, but investors are always trying to price in where the Fed is going. If we think of the market like a dog on a leash then we can think of the market running out in front and testing the owner’s direction. That’s what the market does. And if the Fed wants, they yank the market right back where they want it. The leash is longer the further we go out on the curve because the Fed let’s it work that way.

    Right now, the market is pretty afraid to test the owner because the owner keeps telling the dog not to go anywhere until 2013. That could change in a heartbeat though. If this economy really looks like it’s gaining momentum and the Fed hints at a rate increase we’ll see bonds get smoked. I don’t and haven’t liked bonds since late last year so I basically agree with Cooperman though I don’t think he’s thinking of this the same way I am. I’d like to see the yields move a bit higher before I think the Fed will yank the dog back….

    Does any of that make sense?

  • wh10

    Yep – thanks.

  • LRM

    @ OR

    “But who I am to say? The guy is a billionaire and I am not:-)”
    Well I am no B’aire either . When these influential people say to buy equity now are they on the Bloomberg as a gift to society? On Prag Cap today we had Lance Roberts tell us that the media will lead us to ruin,suggesting now is not the time to buy. We had CR post on China steel and how it’s growth is sputtering suggestion all is not as it seems in China on whom we depend for growth, especially commodity countries and we have Leon basically say stick to equity. These same people or many like Leon were on last year advising to stay clear of bonds which as we all know performed so well last year.
    The guy that has the billion must know something or have better information and ability to have “made it”.
    Should I throw in the towel, buy all equities and go with the flow and stop wasting time in the same arena as these champions?

  • Geoff

    The Fed could indeed change its mind in a heartbeat, but it would lose a great deal of credibility given all its previous statements about remaining on hold until 2013-2014.

  • Octavio Richetta

    The dark side of LTRO:

    http://www.telegraph.co.uk/finance/financialcrisis/9099532/ECBs-Mario-Draghi-magic-corrupts-bond-markets.html

    Super Mario’s actions keep on messing up european debt subordination. This int gonna have a pretty end.

  • Andrew P

    It will get Merkozy past their elections, and that is all that matters to them.

  • Wulfram

    The Fed won’t raise rates substantially before 2014 because it’s probably going to take housing that long to even begin to recover (prices still declining year to year). The Fed might be walking the dog, but he’s been handcuffed to a light pole.

    Why not dump some cash in Series I bonds for a year? Granted you’re limited to $10K a year, but as of now they pay 3.06% and are exempt from state income taxes. This is substantially better than any CD or short term Treasuries. Also, they cannot go below par value, so even if we see deflation again, you’ll still end up ahead. If you redeem it before 5 years, you have to sacrifice 3 months interest, but that is a small penance to pay.

    Also, since gas prices are going up, we should expect to see a large increase in the CPI rate when the bond rate is indexed in May. When that happens, I expect the Series I bonds to yield about 4-4.5% risk free. Obviously you won’t be dining on caviar with those kinds of returns, but you won’t starve or suffer from insomnia either.

  • B Ferro

    “I have great confidence the Fed is ultimately going to get their way.”

    The only investment rule that matters.

    In fact, I would disagree with Cullen’s earlier piece in 2011 that “mis-understanding MMT/QE is a huge hazard to one’s wealth / portfolio.”

    In reality, if I knew, fundamentally, that QE, in the context of MMT, is not money printing, I would have sat out a monster equity rally from summer 2010 into spring 2011. I would have sat there and told myself, “there’s no way QE can drive asset prices higher because it’s a “monetary non-event” when in reality, because the rest of the investing world believed it was money printing, decided to buy stocks as an inflationary hedge.

    In that regard, the less I know about MMT in this world, the better from a trading standpiont.

  • Dan M.

    B Ferro,

    Except we were also running deficits far in excess of our trade deficit (finally), replenishing the balance sheets of Americans of the NFA’s they needed. I don’t think QE can be credited with the huge recovery.

    Further, most of the damage of “not understanding QE” comes in the form of avoiding bonds because “rates have nowhere to go but up,” and screaming inflation from the hilltops.

  • B Ferro

    Dan, I think QE excited the entire recovery in the market from summer 10 to spring 11.

    I believe so (and this is why the morons at the Fed need to be stripped of their second constitutional mandate, that being full employment) because market perception, not reality, is the ONLY thing that matters in the global financial system. You need people who have traded markets and understand them, not monetary policy, at the helm at the Fed…

  • DD

    It’s pump time so Ts don’t look so good but when dump time come Ts will be in style. Inflation? Since when was the last time any country in the developed world had to worry about their economy overheating….

  • Mr. Market

    “”Financial Repression”” ? Yeah, sure. Frankly, I don’t believe a word of it. The FED can only increase or decrease liquidity. Mr. Market determines where that money will be invested.

    Yes, the yield of a T-bond is disastrous low and that indeed makes T-bonds not so attractive. But IMO the money that has moved into the stockmarket since october 2011 WILL – sooner or later – move out the stockmarket AGAIN and move into T-bonds once more AGAIN. Effectively pushing interest rates even lower for the last final time. And those lower interest rates – IMO – could/will finally break the back of a lot of savers. And one class of “”savers”” are the banks. These low rates are one reason banks are trying to increase fees for customers.

    Yes, the FED punishes “”savers”” but the mechanism behind this “”punishment”” is quite different from what the MMT folks assume.