Author Topic: The Great Bond Bubble  (Read 3378 times)

tomsang

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arebelspy

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Re: The Great Bond Bubble
« Reply #1 on: February 22, 2013, 07:46:31 AM »
I'm usually not a fan of Todd Tresidder, but he's spot on here.

This idea has actually been in the news quite a bit lately, with several interviews with Jeremy Siegel saying that bonds are more risky than stocks right now.

Example:
http://www.fool.com/investing/general/2013/02/11/bonds-so-much-more-dangerous-than-you-think.aspx
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Done by Forty

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Re: The Great Bond Bubble
« Reply #2 on: February 22, 2013, 08:10:15 AM »
We have been putting our "next home" savings in VSCGX (60% total bond market fund, 28% total stock market fund, 12% total international stock fund).  Our timeframe to use it to purchase a home would be about 5 years. It currently represents a significant part of our net worth (roughly 20%).

In your opinion, do you think this is not the right place to put these funds given this timeframe? 

Lagom

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Re: The Great Bond Bubble
« Reply #3 on: February 22, 2013, 09:24:04 AM »
I know less than most on this board, but I would not be comfortable with that mix at the moment. In fact, it seems to me that almost all traditional short term savings options right now are far riskier than what is historically normal and/or give attrocious returns. My wife and I are also on a 5 year plan to buy a home and I really have no idea what to do with the savings other than stick it in an online bank at a paltry 0.9% rate. But maybe I need to be talked into trusting bonds more...
« Last Edit: February 22, 2013, 09:27:44 AM by Lagom »

Jack

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Re: The Great Bond Bubble
« Reply #4 on: February 22, 2013, 09:45:46 AM »
The way I think of it, having "good" debt such as a mortgage is (in a sense) equivalent to shorting the bond market.

If I didn't already own a house I'd be modifying my plan to move the purchase date sooner than 5 years, either by earning more money, lowering my budget, using a lower down-payment (e.g. accepting a 3.5% down FHA mortgage instead of a 20% down conventional one, despite the PMI) or a combination of all three.

Since I do already own a house, my goal is to buy rental property ASAP. I haven't decided how to accomplish that yet, though. If I were to try to save up a 20% down payment I'd probably keep that savings in index funds (since I could just change my mind about buying the real estate if the stock values dropped), but I may try to use "creative financing" instead and then refinance or take out a home equity loan afterwards.

tooqk4u22

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Re: The Great Bond Bubble
« Reply #5 on: February 22, 2013, 09:48:21 AM »
I am a bond bear and have been for a while and I have posted here many times saying as much. Long term bonds are crazily overvalued and when the fear trade leaves (already has a little), the bernicke twist ends, the economy picks up steam, or inflation creeps up faster long dated bonds will get crushed, especially if all of them happen.   The questions is when though?

Five year time frame is not long enough to take the risk - cash and short term bonds will lose to inflation but they are safe.  Vanguard has an Intermediate Investment grade fund that will keep pace with inflation but there will be modest credit and interest rate risk, but overall is relatively safe - this could be a good fit for five year needs or more but not much less. 


yolfer

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Re: The Great Bond Bubble
« Reply #6 on: February 22, 2013, 05:02:26 PM »
Yet another "bond bubble" article (video, really). This time from Vanguard. It's even posted on their homepage. https://personal.vanguard.com/us/insights/video/2426-RetExc2-01222013

I'm curious if this is one of those "Be Greedy When Others Are Fearful" moments that Warren Buffett spoke of, or an actual change in the playing field?
« Last Edit: February 22, 2013, 05:07:18 PM by yolfer »

smedleyb

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Re: The Great Bond Bubble
« Reply #7 on: February 22, 2013, 06:02:30 PM »
I am a bond bear and have been for a while and I have posted here many times saying as much. Long term bonds are crazily overvalued and when the fear trade leaves (already has a little), the bernicke twist ends, the economy picks up steam, or inflation creeps up faster long dated bonds will get crushed, especially if all of them happen.   The questions is when though?

Five year time frame is not long enough to take the risk - cash and short term bonds will lose to inflation but they are safe.  Vanguard has an Intermediate Investment grade fund that will keep pace with inflation but there will be modest credit and interest rate risk, but overall is relatively safe - this could be a good fit for five year needs or more but not much less.

I sometimes wonder if the death of deflation -- and thus the immanent demise of the 30 year bond bull -- has been greatly exaggerated.  Throw in the recent collapse in gold prices ($1500 is being tested yet again, and should it fail, look out below) and what I perceive to be an overly optimistic forecast of the return of real estate, the contrarian in me thinks this bull will not go gently into the good night, or at least not before befuddling even the most sage market prognosticator.

arebelspy

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Re: The Great Bond Bubble
« Reply #8 on: February 22, 2013, 06:12:21 PM »
You may be right smedley.  I have heard from some very smart people to be wary of potential deflationary scenarios.

I try to suppress my urge to speculate on those sort of things though; it would take a man wiser than I to do it successfully.
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tooqk4u22

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Re: The Great Bond Bubble
« Reply #9 on: February 22, 2013, 06:36:37 PM »
True deflation would certainly be damaging and difficult to manage through and possibly catastrophic given the amount of public, private, and corporate debt out there - I really hope this is unlikely.  While it is a possibility I don't think it is likely given the fed printing press currently working overtime. Although it is important to realize that while the reported inflation figures have been relatively tame recently housing is approximately 30% of that calculation so declining prices and interest rates resulted in deflationary rent equivalent payments and thus helped keep inflation in check while everything else went up. So in some regard we already experienced a bout of inflation and fed pumping with low rates help keep housing prices up.

As for gold, inflation, the weak dollar, and fear combined with being traded/controlled by a relatively small investor base allowed gold to get well ahead of itself over the last decade and now will decline/flatten as the other asset classes and inflation catch up. 

At the end of the day I think we are at far greater risk for stagflation than deflation, which would be even worse.

But who knows, that is just my 2 cents, which is about all it is worth.


smedleyb

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Re: The Great Bond Bubble
« Reply #10 on: February 22, 2013, 07:08:09 PM »
I agree gentlemen that the threat of deflation appears remote and unlikely given the current efforts of global central banks to reflate their respective economies, but I'm also inherently skeptical of governmental meddling in the operations of free markets and the distortions such meddling produces. 

Has all this cheap money created unsustainable bubbles in the stock, commodity, and real estate markets (Hampton real estate, anybody?) as collapsing yields push investors into taking more risk?   Admittedly the drop in gold may very well be, as Tooq suggests, a reversion to the mean rather than signaling anything more fundamental regarding the future of inflation.  But then again, it could be the smoke signaling deflation's firey return, and an ominous sign that the central banks have lost control of the situation. 

Nobody is bigger than the market, not even the Fed. 

Just attempting to see the other side of the bond debate (even if I'm intellectually drawn to the bearish side of the aisle).

SwordGuy

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Re: The Great Bond Bubble
« Reply #11 on: February 22, 2013, 07:58:29 PM »
There are a lot of cities (and maybe states) that will go broke over the next 10 to 15 years.  They have over-generous and underfunded pension plans that the baby boomers are about to suck dry in short order.

fiveoh

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Re: The Great Bond Bubble
« Reply #12 on: February 22, 2013, 09:09:00 PM »
Yet another "bond bubble" article (video, really). This time from Vanguard. It's even posted on their homepage. https://personal.vanguard.com/us/insights/video/2426-RetExc2-01222013

I'm curious if this is one of those "Be Greedy When Others Are Fearful" moments that Warren Buffett spoke of, or an actual change in the playing field?

People are still invested in bonds in record amounts so I dont think that applies here. 

dragoncar

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Re: The Great Bond Bubble
« Reply #13 on: February 22, 2013, 09:44:32 PM »
Yet another "bond bubble" article (video, really). This time from Vanguard. It's even posted on their homepage. https://personal.vanguard.com/us/insights/video/2426-RetExc2-01222013

I'm curious if this is one of those "Be Greedy When Others Are Fearful" moments that Warren Buffett spoke of, or an actual change in the playing field?

People are still invested in bonds in record amounts so I dont think that applies here.

"people" meaning the fed?  Genuinely curious (I have plenty myself)


KingCoin

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Re: The Great Bond Bubble
« Reply #15 on: February 25, 2013, 08:51:31 AM »
A. Gary Shilling lists some reason why he likes bonds:
http://www.bloomberg.com/news/2013-01-30/where-to-invest-while-markets-remain-risk-on-.html

Shilling is a perma-bear, so I'd take his views with a large grain of salt. It's easy enough to cast doubt on most of his arguments. Especially the fairly embarrassing support item: "And because Treasuries have worked for me for 31 years, and the 30-year long bond has been one of my most profitable investments."

Bonds are almost universally hated at the moment which is atypical of most bubble assets. Might not be a bad contrarian play, and as a hedge, they're more effective than most assets. I would load the boat with treasuries, but holding 10% is your portfolio is hardly crazy.

As for smedleyb's claim that low yields might be leading to bubbles in other asset classes, I don't see any obvious ones. Stocks, real estate, and commodities all look fairly reasonable (if not cheap) vis-a-vis historical metrics. If anything looks rich, it's gold, which is surely already pricing in a lot of inflation.

arebelspy

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Re: The Great Bond Bubble
« Reply #16 on: February 25, 2013, 10:03:02 AM »
Bonds are almost universally hated at the moment which is atypical of most bubble assets.

I donno, I feel like the hate starts to grow among the sophisticated right before the bubble bursts.  For example, real estate got hyped in 03-06, but before the bubble burst in 06-07 there started to be a TON of articles on how it was overvalued, etc.

I feel like that's what's happening to bonds at the moment.
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KingCoin

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Re: The Great Bond Bubble
« Reply #17 on: February 25, 2013, 10:55:19 AM »
I donno, I feel like the hate starts to grow among the sophisticated right before the bubble bursts.  For example, real estate got hyped in 03-06, but before the bubble burst in 06-07 there started to be a TON of articles on how it was overvalued, etc.

That's interesting. It's surprising that information didn't trickle up to institutional investors. Or maybe by the time it did, the damage of toxic issuance was already done.

tooqk4u22

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Re: The Great Bond Bubble
« Reply #18 on: February 25, 2013, 12:28:50 PM »
Bonds are almost universally hated at the moment which is atypical of most bubble assets. Might not be a bad contrarian play, and as a hedge, they're more effective than most assets. I would load the boat with treasuries, but holding 10% is your portfolio is hardly crazy.

They are far from universally hated when you have the fed pumping endless amount into buying them along with the fear trade due to Europe, which is the real bubble element - inflation is a close second but the first two if improved will cause rates to rise fast and furious and at least 1.5-2.0%.  But having a small piece of AA in them isn't crazy either.

As for smedleyb's claim that low yields might be leading to bubbles in other asset classes, I don't see any obvious ones. Stocks, real estate, and commodities all look fairly reasonable (if not cheap) vis-a-vis historical metrics. If anything looks rich, it's gold, which is surely already pricing in a lot of inflation.

Its not obvious but there are inflated prices in real estate - if not for the low mortgage rates for residential and low borrowing costs for commercial/investor all property values would be significantly lower right now.  Equities are also being frothed up (I don't necessarily think they are overvalued or in a bubble state)  due to the relative return argument and companies benefiting from low borrowing costs - while they may appear cheap by historical metrics you have a 17 p/e on teh S&P 500 - not cheap, but not crazy but when including expected growth (low or slow) it looks pretty expensive.

This is all good but it can get out of control.

I donno, I feel like the hate starts to grow among the sophisticated right before the bubble bursts.  For example, real estate got hyped in 03-06, but before the bubble burst in 06-07 there started to be a TON of articles on how it was overvalued, etc.

That's interesting. It's surprising that information didn't trickle up to institutional investors. Or maybe by the time it did, the damage of toxic issuance was already done.

Remember though that institutional investors didn't buy housing, but they did buy the AAA tranches of the CDO/SIVS and other exotics and utterly failed to understand the counter party risk, negligence of rating agencies, and the sequential impact to other companies/industries.

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Re: The Great Bond Bubble
« Reply #19 on: February 25, 2013, 01:41:56 PM »
I have to say, I am a bit worried about the implications of this whole bond bubble thing. This article made a lot of good points which have been obvious to me for a couple years now. With the Fed constantly buying bonds though, I don't know exactly how people are going to start hating on them, but at some point the market is going to go against Bernanke and something interesting will have to happen. Hopefully it'll just mean high inflation for a few years and a manageable economic slowdown and decrease in purchasing power as debt gets paid off. Given that it's such a global issue though, who knows.

I think investors gotta stay away from long term bonds though. It's tempting because of Bernanke, but you better believe the exit is going to be crowded if people start to think he will let up. It's like playing chicken; high stakes and only works if you time it perfectly. Seems like a classic bubble situation.

KingCoin

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Re: The Great Bond Bubble
« Reply #20 on: February 25, 2013, 02:00:52 PM »
They are far from universally hated when you have the fed pumping endless amount into buying them along with the fear trade due to Europe, which is the real bubble element - inflation is a close second but the first two if improved will cause rates to rise fast and furious and at least 1.5-2.0%.  But having a small piece of AA in them isn't crazy either.

Maybe universal is too strong, but I'd say the negative to positive opinion pieces are at something like 20/1.

Its not obvious but there are inflated prices in real estate - if not for the low mortgage rates for residential and low borrowing costs for commercial/investor all property values would be significantly lower right now.  Equities are also being frothed up (I don't necessarily think they are overvalued or in a bubble state)  due to the relative return argument and companies benefiting from low borrowing costs - while they may appear cheap by historical metrics you have a 17 p/e on teh S&P 500 - not cheap, but not crazy but when including expected growth (low or slow) it looks pretty expensive.

This is all good but it can get out of control.

On real estate, if rates rise, that implies a stronger economy, which should boost housing prices (or at least keep them stable). Agreed that stocks aren't cheap.

Remember though that institutional investors didn't buy housing, but they did buy the AAA tranches of the CDO/SIVS and other exotics and utterly failed to understand the counter party risk, negligence of rating agencies, and the sequential impact to other companies/industries.

Yeah, it makes sense that the boots-on-the-ground guys would be the first to notice that the only way to profit would be flipping to a bigger fool.

While I don't intend to be a bond cheerleader, it's worth looking a place like Japan where the 10y rate has been below 2% for nearly 20 years, and have actually been trending even tighter for the last year.

I don't buy the argument that the government is going to push inflation as a means of solving the debt problem. Issuance right now is huge compared to existing stock, a large percentage of the debt is front loaded, and most of our future liabilities are real rather than nominal expenses (healthcare, social security, defense). That makes rising short term rates much more costly than a few extra points of inflation are going to help.

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Re: The Great Bond Bubble
« Reply #21 on: February 25, 2013, 02:14:52 PM »
I donno, I feel like the hate starts to grow among the sophisticated right before the bubble bursts.  For example, real estate got hyped in 03-06, but before the bubble burst in 06-07 there started to be a TON of articles on how it was overvalued, etc.

That's interesting. It's surprising that information didn't trickle up to institutional investors. Or maybe by the time it did, the damage of toxic issuance was already done.

I helped on the work out of some of these CDO issues (and had access to email chains) and think both explanations are true.  Some of the European and Asian banks kept snapping up yield until the very end -- they just didn't quite seem to be in touch with reality.  On the other hand, AIG got nervous and stopped writing CDS's some time in 2006, if I recall correctly.  Unfortunately, they already had a lot of super senior exposure at that point.

And I second ARS.  I've been pulling economic research published in 2005-2006 for a different project I'm working on, and there were a lot of people saying that housing was overvalued by the second half of 2005.  Most articles I'm reading do focus on Florida and California, however.

tooqk4u22

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Re: The Great Bond Bubble
« Reply #22 on: February 25, 2013, 02:26:27 PM »
On real estate, if rates rise, that implies a stronger economy, which should boost housing prices (or at least keep them stable). Agreed that stocks aren't cheap.

That is only partially true - a stronger economy will cause rates to rise primarily due to the relative return argument and possibly due to inflation.  But the fed purchase and europe fear trade are resulting in artificially low rates, which as I stated above is easily 1.5-2.0% (could be more) so if those two things change that is the portion that will be quick and not natural and is what to be careful of. 

While I don't intend to be a bond cheerleader, it's worth looking a place like Japan where the 10y rate has been below 2% for nearly 20 years, and have actually been trending even tighter for the last year.

This would be the true contrarian or we're f'ed scenario - but your absolutely right that it is a legit possibility - the pessimist sees this as a real possibility but that is offset by my view the US economy being dynamic and diversified - but if you think we are in for a decade or two of really low growth and deflation then bonds look really good.

I don't buy the argument that the government is going to push inflation as a means of solving the debt problem. Issuance right now is huge compared to existing stock, a large percentage of the debt is front loaded, and most of our future liabilities are real rather than nominal expenses (healthcare, social security, defense). That makes rising short term rates much more costly than a few extra points of inflation are going to help.

Inflation can help solve debt issues and those other things while growing with inflation can be cut/modified in the future (hahahahahahhahahahahaha sure than can but will they-current history suggests otherwise)

The bigger issue is that inflation won't help with the debt as the majority of outstanding fed debt has less than five year maturities - think about how those will reprice if inflation comes up.  The US is doing exactly what got the US homeowner in trouble and is what greece is struggling most with - repricing of near term rate maturities.

If the US intends to continue to act like a drunken sailor with an unlimited credit card - the very least it can do it is fund it on a 30 year mortgage at these low rates so inflation can in fact help. 

Mr Mark

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Re: The Great Bond Bubble
« Reply #23 on: February 25, 2013, 09:20:01 PM »
That's why:
- already only 15% in shortish-term bonds
- go for a % of stash in income producing assets like quality real estate with a mortgage of 3.x% nominal, fixed for 30 years.

If you are that scared of bonds, take the other side of the trade and borrow fixed for 30 years against quality, inflation proofed assets.

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Re: The Great Bond Bubble
« Reply #24 on: February 26, 2013, 03:13:46 PM »
The concern is that the bonds prices will decrease as interest rates rise.  I agree that I don't think deflation is likely, and with the current govt interventin, you will probably see it go the other way first.  If the interest rates do rise those (particularly hedge funds, investment banks, endowments, etc...) with large positions will see the value of their portfolio plummet because of the duration of the bonds they are holding.  Duration causes the bond price to fluctuate drastically in comparison to the change in interest rates.  If you want more info on duration, I suggest checking out PIMCO's website (link below) and looking into both Macaulay Duration and Modified Duration.

If you are holding bonds to maturity, and arent lookingto sell your bonds, then you probably dont care about duration at all.  The only potential negative impact if interest rates rise and you have a lower yielding bond is opportunity as that point.  If, however, you holding bonds short term and plan to sell prior to maturity, then the "bond bubble" could impact you if interest rates change.

http://www.pimco.com/EN/Education/Pages/Duration_Basics.aspx

projekt

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Re: The Great Bond Bubble
« Reply #25 on: February 27, 2013, 10:10:20 AM »
If "sequestration" occurs, and it appears it will, it will be very deflationary.

ER4EVA

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Re: The Great Bond Bubble
« Reply #26 on: February 28, 2013, 03:13:28 AM »
Hi,

I currently live in the UK which is doing very well at trashing its currency. I have been holding the UK government bonds (gilts) in my pension plan but have decided to switch them for a world equity index.

I have done this for several reasons
1. UK debt summed up is approximately 900% of GDP - Insane
2. The central bank wants to print more money and is talking about -ve interest rates
3. Equities are real businesses competing for profits without government intervention

They are stealthily debasing the pound so bonds in the UK are a bad idea in my opinion. In the US at least there is the world reserve currency and if the Eurozone, UK or Japan run into difficulties (likely) there will be a rush into dollars. Will this prop up the US bond market longer than expected probably.

My main investment portfolio stays away from bonds as well keeping to funds and blue chip global dividend paying stocks. I will just have to ride out the next market dip when it comes.

projekt

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Re: The Great Bond Bubble
« Reply #27 on: February 28, 2013, 09:05:14 AM »
http://www.xe.com/currencycharts/?from=GBP&to=USD&view=10Y

The relative value of the GBP dropped significantly from the crisis itself. Since then, there has been 3% annual price inflation. Very interesting. I think the debasing has already occurred, but more can always be done. It shows a lot about the realities in Britian, where so much has to be purchased from Europe. Unfortunately for them, the ECB is trying to prop up the currency at any cost. Very good for German exports, not so much for British consumers, lousy for Irish workers who have been subject to "internal deflation".