We might as well get used to it; rates are likely to stay lower for longer.
All around the world, there are around $17 trillion in assets "offering" negative yield, which is to say whatever government you're financing promises to give most of your money back at maturity.
Investors are seeking the return of their money rather than return on their money.
Here in the United States, the president is pounding the table for lower interest rates to boost the economy; the Fed is speculating openly about a global slowdown and a protracted trade war.
Same old, same old.
The only ones that even hint of something different are the "permabears" - you know, the folks who always talk about doom, gloom, and the end of the world.
So, oddly enough, I find myself asking...
What if they're right?
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A Weirdly Profitable Track Record
Permabears aren't right all that often, but boy were they right in 2007 and 2008; they made a fortune. Granted, many of them lost a good chunk of that fortune being too bearish since 2009, but at the time, they made unbelievable piles of cash.
You know what they say about busted clocks: They're right twice a day.
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I'm a huge fan of Nassim Taleb - the trader and mathematician who wrote "Fooled by Randomness" and several other classic investment and life advice books.
Taleb is among those who made a fortune on both of those occasions, but unlike many others who share his pessimism, he's been able to keep his.
He did this using what's called a "black swan strategy."
See, "everyone" is often wrong, especially when it comes to the market - and the probability of a black swan event, while low overall, is actually higher than the conventional wisdom would indicate.
Taleb understood that if the odds are high enough, then it's wildly profitable to make small bets on unlikely events.
I think that's exactly what we have in the Treasury bond market.
The price of the long bond exchange-traded fund (ETF), the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT), has shot from $130 to $145 in just a month.
A move of over $10 in the stock markets is unusual, and it's even rarer for a "safe" asset like U.S. government bonds.
In November 2018, it was all the way down at $115. No allegedly rational observer thinks we will get back to that level anytime soon, so that's exactly the bet I think we should make.
And we'll make a small, cheap bet; there's no need to make a big bet. A small bet will pay off more than enough to make it worth placing.
On one hand... we could outright sell TLT short, but there's a real chance of permanent painful disaster for doing so. Sometimes the crowd is right, and the key to executing a black swan strategy is making sure the losses aren't painful enough to notice.
To do that, we have to go to the options market.
We also want to buy some time. A series of short-term bets could add up to a tidy sum before something finally disrupts interest rates and we get paid.
Fortunately, the Chicago Board Options Exchange has contracts going all the way out to January of 2021, so we can just make one bet to cover 16 entire months.
Before I suggest which option to buy, let's talk about some of the reasons Treasurys could fall back below $130 and maybe even all the way back to $115...
Here's What Could Make the Improbable a Reality
First, keep in mind that for TLT to hit $115 implies long-term interest rates of just a little over 3%. That's not outrageous, even the for the U.S. government, with a 20- or 30-year maturity.
The bond market could, over time, decide to reprice the risk of lending to the United States - particularly if (or, more likely, when) our deficit just keeps rising.
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Second, the permabears might be right this time. Remember what I said about busted clocks.
Printing all of this excess money and keeping rates lower for longer just might cause an inflationary surprise, and there ain't a central bank on the planet right now with enough ammo to fight that if it happens.
We could see developments in the Middle East that cause oil prices to skyrocket and push inflation and interest rates higher.
China could sell Treasurys as a trade-war tactic, putting pressure on U.S. bond prices.
A sweep of the White House and Congress by the Democratic Party led by the far left would almost certainly cause a repricing of risk, as the spending programs and monetary policies they espouse are viewed with a great deal of skepticism by most economists.
Lest you think I'm getting partisan, consider that a sweep by the GOP could spur selling; markets could develop fears that continued tax cuts could cause the deficit to soar to really dangerous levels.
You get the picture. This isn't exactly science fiction; it's not at all unreasonable to make a bet like this.
Here Are the Best Options in the Chain to Buy
My main point here is that it doesn't even take a few bourbons to develop very plausible and probable theories about why interest rates could jump up in price.
And none of these possibilities are priced into the options contracts right now - even those with 16 months left until expiration.
My approach would be just to buy the first put strike with January expiration that I could buy for less than $1 a contract. Each contract allows us to sell 100 shares at the strike price between now and Jan. 15, 2021, and each option consists of 100 contracts.
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Right now, the TLT Jan. 15, 2021 $85 puts (TLT210115P00085000) are selling for just $0.14, and you can run down the chain all the way to TLT Jan. 15, 2021 $113 puts (TLT210115P00113000), which are trading for $0.99.
So the cost, not including fees or commissions, could run anywhere from $15 to $99 if you're feeling really adventurous.
Now, we don't need prices to fall all the way back to $115 to make money.
Options pricing is a three-legged stool, with price, interest rates, and volatility being the main components.
Right now, volatility is very low, and a downward move would send volatility screaming higher, making prices multiply very quickly.
For instance, if we bought a TLT Jan. 15, 2021 put for $0.80 last Friday, and six months from now the price of the TLT fell to $113, our options could be worth as much as $3.15 if TLT volatility went back to the 52-week high.
An event on the magnitude of public dumping of bonds by China would send volatility screaming higher as prices collapsed, at which point we could see gains of 10 times our bet or more.
We make money from the price movement, and the volatility increases even if the option never actually trades at our strike price.
The key to making a black swan strategy work is to keep the stakes small, because they won't all work. In this case, we're risking anywhere from $0.15 to $0.99 - stakes don't come much smaller than that!
If you executed a black swan strategy with a 50% win rate, you would pile up unbelievable sums of money in fairly short order.
If I'm wrong, I want to lose a tiny amount... you know, like a quarter... but if I'm right, I get a payoff that adds a nice chunk of change to my piggy bank.
Nobody thinks interest rates will go higher. For that reason alone, a small bet with high payoff potential makes sense.
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About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.