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This Popular Trade Is a Comfort Trap

By Tom Dyson, publisher, The Palm Beach Letter
Tuesday, September 1, 2009

You'll sleep soundly at night. Your neighbors won't laugh at you. Your pulse won't budge. But if you make this trade, I guarantee you'll lose money...

I call this trade a "comfort" trade. It's one of those trades that please your every investment instinct. If you've ever bet on Tiger Woods, you know what I mean...

Tiger Woods never misses clutch puts. When he misses the fairway, he usually escapes with par. And he always comes up with the big shots when he needs them.

In short, betting on Tiger Woods is usually an 18-hole experience in feeling wonderful.

Here's the thing: Despite Tiger's miracle shotmaking skills, betting on Tiger is always a bad investment. Bookmakers expect him to win every time he plays. Whenever he fails to meet these unrealistically high expectations, you lose. Even if Tiger comes second, you lose.

I've found the same dynamic at work in the stock market...

"Comfort" trades jibe with the financial headlines. Comfort trades seem certain to make money. Comfort trades envelop you with greed when you consider them. The majority of investors flock to comfort trades. So by taking them, you end up on the same side of the trade as the crowd. And that's always where the losses are...

Richard Dennis was the trading king of Chicago during the 1970s and 1980s. He used to say, "If [a trade] feels good, don't do it."

William Eckhardt is another trading legend, generating 60% returns per year for over two decades. "Do the [trade] you least want to do," he advises.

Betting against Treasury bonds is the world's most comfortable trade right now.

The U.S. government is cranking out billions of dollars worth of Treasuries each week. Over the last three months, it's issued $200 billion in 30-year bonds and 10-year notes. This is the largest issue of long-term debt in mankind's history. This issuance will continue for years...

The economy is recovering. Housing data has rebounded, consumer confidence is up, and unemployment has improved. Even Fed Chief Bernanke thinks the worst is behind us. Government bonds lose popularity when investors get excited about growth.

Finally, the Fed's been buying Treasury bonds as part of its Quantitative Easing program. Last month, the Fed announced the end of this program. In other words, it will soon stop supporting the Treasury bond market.

In short, it's a slam-dunk bet that interest rates on government debt have to rise. You'd have to be an idiot to bet against the price of U.S. government debt right now. But wait...

These incredibly obvious headlines tell me the world has bet against government debt. The numbers back up my hunch. Right now, large speculators have the biggest net-short position in 30-year bond futures since July 2007... and the second-largest short position of all time.

With the crowd betting so heavily on the short side of the Treasury bond market, we're almost certain to see a large move in the opposite direction.

The U.S. government is broke, and in long term, its bonds are worthless. In my DailyWealth column on January 5, I told you the government bond market had peaked and Treasury bonds were heading for a crash. (I wrote that just three days after the peak.)

The U.S. government is still broke, and its bonds are still worthless. The problem is, everyone knows this now... and they've already placed their bets against government bonds. So by making this bet, you're betting on Tiger Woods. It's comfortable, but you'll probably lose money.

My advice: Wait for everyone to love government bonds again before you bet against them. You'll probably get this opportunity later this year. In the meantime, leave this bet alone. It's a comfort trap...

Good investing,


Market Notes


Insights from the "muni bond" market today: Doc Eifrig is right... You can make a lot of money buying what nobody else wants.

Two months ago, we featured an essay from Retirement Millionaire editor Dr. David Eifrig. His advisory focuses on wealth strategies for folks at or near retirement age. In what sounded crazy to most people, he said buying municipal bonds issued by California was a great income idea. Readers wrote in to ask, "Has Eifrig lost his mind? Doesn't he know California is in real trouble?

Sure... things are bad in California right now. But now – more than ever – we encourage you to invest and trade on the side the federal government is on. Its new "spend and tax our way to prosperity" policy is crazy, but it has a big pile of money to play with, so we have to mind its actions. If it's going to bail out Chrysler, you can be sure it's going to bail out California and back up its debt obligations. You'd have riots from San Diego to Sacramento if the feds said, "No money for you."

Today's chart shows this government backing at work. It's the past year's trading in a huge California municipal bond fund, symbol MCA. After a severe decline during the credit crisis, MCA has enjoyed a steady government-backed rise. It's up 14% in the past two month alone. More proof that it pays to buy what nobody else wants... and it pays to trade on the side of the government.

The bull market in California's bonds

In The Daily Crux

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