Why I’m Shorting the Safest Investment in the World

I’ve always had a contrarian streak.

Conventional wisdom is more a jumping off point for me than it is an anchor for my investment decisions. And I’ve found it usually pays off handsomely to follow my own research rather than Wall Street’s.

Case in point: In the spring of 2007, I put a sizable chunk of my personal portfolio into certificates of deposit (CDs) and the iShares Barclays 7-10 Year Treasury ETF (NYSE: IEF). It was the first time in my more than 25 years of investing that I bought anything to do with Treasuries.

I was worried about the health of the financial system and the possible spillover of the subprime crisis into the general economy, even as most pundits were whistling past the graveyard. By the summer of 2007, I wondered if I had overreacted. Even as the largest U.S. subprime lender, New Century Financial, filed for bankruptcy and HSBC (NYSE: HBC) wrote down more than $10 billion in bad mortgage loans, the stock market was still humming along.

In fact, by July 2007 I was actually losing money on my Treasury position. A few months later, however, I was happy I had stuck to my plan.

#-ad_banner-#Come the fall of 2007, investors began to seek out the classic safe haven of Treasuries, slowly driving up the price of IEF. In total, I booked a nice +22% profit when I sold IEF at the beginning of 2009.

That’s not a particularly huge score. But compared with the roughly -40% drop in the S&P 500 over that time, it felt like a windfall. That’s what being a contrarian can do for you.

And believe it or not, I’m feeling contrarian again about Treasuries… but this time it’s different.

That was then, this is now

It’s easy to understand why the price of Treasuries was high back then. In 2008, we saw notable bankruptcies across many industries as the financial crisis ensued. We saw the epic collapse of AIG, Bear Sterns and Lehman Brothers. Big retailers like Circuit City and Linens ‘n’ Things closed their doors. And General Motors and Chrysler were teetering on the edge.

Few investments seemed safe. Investors flooded into Treasuries — considered the safest investments in the world — to simply ride out the storm. It didn’t matter how little they yielded.

Oddly enough, Treasuries are still trading at highs. For instance, IEF traded at a high of $100.31 on December 18, 2008. On Monday it closed near $97 per share.

I’m feeling just as I did back in the spring of 2007. Treasuries feel mispriced. But instead of trading on the low side as they did back in 2007, they seem very high for the current economic conditions.

Now, I don’t believe the U.S. Federal Reserve is going to raise interest rates soon. In fact, they tried to damper them with the recent announcement of quantitative easing.

Nor do I believe the economy is going to overheat, by any means. Employers aren’t rushing to hire. But I do feel the investing and economic landscape has significantly changed from the crisis-ridden times when investors had to settle for a 2.5% 10-year Treasury yield.

Action to Take –> With all this in mind, I decided to do something last month that again went against the grain and against the conventional wisdom: I showed my Stock of the Month subscribers an easy way to short Treasuries, and did just that in my newsletter’s $100,000 real-money portfolio.

And in my research, I even found a number of respected bond players and investment managers that were coming to similar conclusions. They were either selling large chunks of their Treasuries positions or outright shorting them.

Still, with quantitative easing on the horizon, my call seemed somewhat out of the box at the time. But it has paid off well: my subscribers and I are up +10% since October.

Keep in mind that shorting Treasuries is not risk-free by any means. If we were to see another downturn, I’d expect investors to pile into the securities, raising their price and hurting my position.

But at this point my move is paying off nicely, even if it is against the grain.

P.S. — Out of fairness to my Stock of the Month subscribers, I can’t give the name of the security I use to easily short Treasuries. After all, it’s one of only 12 holdings I’m allowed in my portfolio. But if you’d like to learn more about Stock of the Month — including how to see all my holdings risk-free — I invite you to read this memo.