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Forget Stocks, What Happens When the Bond Bubble Bursts?
As I’ve
stated in countless article before, the Fed is good at nothing but blowing
bubbles. And while most commentators have focused predominately on the bubble
occurring in stocks (if you compare where the S&P 500 is relative to
economic data we are DEFINITELY in a bubble), a larger, more frightening bubble
is currently brewing in bonds.
Since the
2008 Crash, investors worldwide have generally shunned equities in favor of the
perceived safety of the bond market. Nowhere is this more apparent that in the
retail investor market, where investors have pulled money from stock based
mutual funds for 23 weeks in a row, while they’re on pace to pile some $300
billion into bond funds this year (on the heels of a record $350 billion in
bond fund inflows from last year).
This trend
in the retail investor market is largely based on fear of stocks (two bubble
and subsequent Crashes in ten years will do that) and demographics (the aging
boomer population, now punished by a Federal Reserve hell-bent on keeping
interest rates at zero, is ravenous for income to help them move into their
delayed retirement).
On the
surface, this sounds pretty good. After all, stocks haven’t returned anything
in ten years. In fact, adjusted for inflation, they’ve LOST money over that
time. Plus bonds DO offer the appeal of definite income compared to stocks
,which often don’t pay ANY dividend or can experience large dividend cuts due
to management screw ups or phony accounting coming home to roost (see
financials from 2007-2009).
However, the
numbers don’t lie, we are most assuredly in a bond bubble. According to data
compiled by Bloomberg and the Washington-based Investment Company Institute,
investors have put almost as much money into bond funds in the two years ended
June 2010 ($480 billion) as they did in equity mutual funds at the height of
the Tech bubble from 1999-2000 ($496 billion).
And the insanity is literally across the board.
Treasuries are trading at levels not seen since the depth of the 2008
Crisis. We just had a TIPS auction close at a negative yield for the first time
in history, meaning investors are willing to LOSE money just to park it with
bonds that supposedly adjust for inflation (TIPS adjust based on the CPI which
is nowhere near the REAL rate of inflation… see tomorrow’s essay for more on
this), and US corporations have ALREADY issued $217 billion in junk bonds this
year, even HIGHER than last year’s RECORD.
In plain terms, we’ve got a bond bubble of epic proportions on our
hands. And if you think a stock market crash is something to behold, wait until
the bond bubble bursts.
Remember, we’ve been in a bond bull market for well over 30 years. And
while stocks have experienced at least three Crashes during that time (1987,
2000, and 2008), bonds have generally done nothing but go up over that period.
Because of
this, there is an entire generation of professional traders/ analysts/ fund
managers who have never invested during a bear market in bonds. These folks
have made their entire professional careers investing with the basic
understanding that debt is cheap and bonds overall move higher.
Can you
imagine what kind of impact a bond market collapse (and higher interest rates)
would have on these folks? Their trading programs and algorithms were created
decades AFTER the last bear market in bonds ended. They are totally unprepared
for this.
If you have
not taken steps to prepare your portfolio for what’s to come, NOW is the time
to do so BEFORE the bond bubble bursts.
Good
Investing!
Graham Summers
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Oh, that's easy ... TARP-XII. Nobody fails, but everyone loses in Treasury Land.
So here we are, about a week away from the elections and the Fed's next announcement. I figure most of the people in the know already have the Fed's decision and have traded accordingly while the rest (and the majority) are left to make their best SWAG. Has anyone ever witnessed a market where just one party, the Fed, has such influence? As the old saying went, you never let the tax tail wag the ecomomic dog. If this was applied to the market, you should never let the Fed tail wag the economic (or market) dog. But this is exactly the scenario being played out. Man is this market screwed up or what.
As for the bond bubble, I would agree that either way you play it, it's a losing proposition. If rates rise (most likely on the longer issues), your principal is going to get creamed. If rates stay low or actually decrease, well then inflation is going to eat your investment alive as although you will get your dollars back, they'll buy about half of what they do today.
And one final thought on the Fed's action is this. While I'm expecting them to disappoint the markets next week, over the long-term, they will have to continue to step in with different forms of QE (so while each effort may be small by itself, in total, all QE efforts will reach into the trillions). The Fed knows that any increase in rates will hammer commercial real estate, residential real estate, bond prices, equities, commodities, etc. Combining this with higher debt service requirements for governments would crush the economy, resulting in even lower tax receipts, and speed the process of debt defaults.
Does the USD have a couple more runs left, I think so but given that ultimately, the USD's value is backed by the relative strenght of the US economy (weak at best) and financial condition of the US Government and Fed (both extremely overledged with basically no real assets to back the enormous debt loads), its long-term outlook is very bleak. In any case the prospects for the USD in ten years is the same. It is going to buy far less than it does today.
TIPS have a lot of optionality because of the floor under the principal payment.
They've become a bet on inflation/deflation volatility.
They might be a good spec with the crazyiest, deficit-loving, RepubliKeynesians in history about to enter Congress - from behind.
I am "trying to imagine it." Was hoping there might be some "color to this blood." Here's my take: if it's a bubble it appears particularly located in Treasuries and not for corporates in the sense that "corporates are taking advantage of the exceptionaly low rates." Smart guys, no? Maybe not worth every penny but sure says to me "they're doing their job." Now with tax rates soaring nationwide "you might think with no funding crisis whatsoever in government this is more than just a little odd." And indeed it is, no? In short and as expertly discussed by these "and I would have succeeded but for those ZH'ers" here "this real estate thing is catostrophic." and thus "the realities behind a treasury bubble" involve some "very uncharted water" PROVIDED it is one AND "it will burst at some time." It has been argued that "this is an unpoppable bubble." My color? Picture a "New York state nationalist" and "Texas nationalist." That's my view.
The bond market bond is going to break just like the current stock market bubble will give way. Credit will become nonexistent just like during the crash of 2008. In our current economic situation dependent upon cheap debt, it will be deflationary in nature. The result will be a deflationary debt collapse.
That would result in default, which means a USD near zero, which means gold/silver to infinity. Not going to happen - Fed will monetize all that debt to avoid a default, but you get the same result: USD collapse. Gold wins either way.
The Fed can print to infinity. Helicopter Ben is impotent at this point. The amount of debt in the US is ~$53 trillion +. Printing is not going to pay this back. Who are we kidding? After debt was already defaulted upon during the debt collapse, hyperinflation will follow.
Gold will win in the long run.
this will pressure commodities to go even higher. many many people have to put their savings somewhere.
http://covert2.wordpress.com
Demand falling faster than QE suggests -38% lower commodity prices like today
http://stockcharts.com/charts/gallery.html?s=auy
Yes. There is simply no more room on the downside for interest rates. All the delta has to go the other way.
Japan is at a tipping point. They are about to become net borrowers in the global market. To get a feel for what that means, what if Saudi Arabia became an oil importer? OMFG
No room on the downside for rates? I disagree. Rates are going to go down when the US Fed really ramps up the QE programs. QE2 followed by QE3 and 4 and 5 and......All that fake money is going to buy bonds and drive rates down for a long time until it cannot any longer.
Bonds are a raging buy on any blip up in rates as there is a perpetual buyer sitting in the wings at all times with unlimited funds.
That's what they want you to believe, but game it out.
How much money can you make if the 10 year goes from 2 % to 1 %, as opposed to your loss if it goes to 8 %? Bonds are a fool's errand, because the rates are ridiculously low. The buyer can't win.
If deflation continues, the default risk kills you, and it will get priced in.
If it's inflation... you know the rest.
Commodity prices will spark hyperinflation long before QE -3. This is end game.
You can double your money if the TNX goes from 2% to 1%
That can happen either with more QE's or debt default deflation
http://stockcharts.com/charts/gallery.html?s=%24tnx
UTN currently targeting 168 from 126
http://stockcharts.com/charts/gallery.html?%24UST
Here's Bill Gross himself to tell ya the 30 year bull market in bonds has died. Is he running a bait and switch?
http://www.pimco.com/Pages/RunTurkeyRun.aspx
Pimco Article:
'Ben Bernanke, however, will try – it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do, and as he proceeds, the dual questions of “will it work” and “will it create a bond market bubble” will be answered.'
Gross also says vote out Rep. & Dem.
That goes to stop buying into the bubble and cut Washington spending. It Bernanke's plan does not work, the untried austerity plan will be moot.
"Their trading programs and algorithms were created decades AFTER the last bear market in bonds ended. They are totally unprepared for this. "
Sounds like the modelers that showed housing prices only go up because they only used 2 years worth of data.
Well they have done models out to the 1920s but the results did not confirm the current political thesis...
Those calling for the end of the Bond Bull market that began on 1981 were premature since at least Dec 2009.
Long Bonds currently targeting 178 from 131, with Long yields as low as 2.519%
http://stockcharts.com/charts/gallery.html?%24usb
http://stockcharts.com/charts/gallery.html?s=%24tyx
just confirms that it is a bubble