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Bond Bubbles! Bond Bubbles!

Bond bubble talk is rife these days. Maybe it's because we've become, as one economist put it, "armageddon hypochondriacs." Recent experience leads us to believe that markets are always on the brink of insanity and meltdown.

Others disagree. Slate magazine's Daniel Gross, one of my favorite business writers, recently penned an article refuting the idea that bonds are in bubble territory. It's a good read, but most of his arguments aren't terribly convincing.  

Says Gross:

[B]ubbles are generally driven by greed and fearlessness. Investors jump in thinking they have nothing to lose and are certain they can get a massive return. ... But today's bond buyers are driven more by fear than by greed. They're not buying government bonds because they think they can double their money by December, or get a 50 percent return in a year by finding a series of greater fools. In fact, it's the opposite. U.S. government bonds are the ultimate safe haven, the least bad place to invest. People are buying government bonds with paltry yields because they can't think of anything better to do with their cash.

I'm not so sure. First, people used the same argument during the housing bubble: that investors were plowing into real estate -- an apparent "safe haven" -- only because they couldn't think of a better place to put their cash after being burned by the dot-com bust. Not knowing what to do with your cash doesn't make you any smarter. Much less so, in fact.

And I don't think bubbles have to be associated with dreams of massive returns, so much as dreams of impossibilities and unlikelihoods. That can happen in fear bubbles, as some would characterize the driver of today's bond market as, in just as powerful a way as bullish ones. The driver of fear bubbles is the same attitude that drives bullish ones: Investors take an extreme event that prevailed in the recent past and extrapolate it into infinity. In either case, the result is lunacy.                                                                             

The neverending story
With 10-year Treasury rates well below 3%, what fear-driven hell is the bond market extrapolating into infinity today? A world with perpetually slow growth, negligible inflation, and a Federal Reserve capable of keeping interest rates low by purchasing public debt by the trillions. The last two points eventually become mutually exclusive (perhaps before long), which seems reason enough to think the bond market has lost its noodle.

That aside, the example most cite as justification for hibernating in bonds is Japan's infamous lost decade, where bond yields faceplanted in the '90s and have remained there ever since. Japan had a big deflationary recession. We've had a big deflationary recession. Thus, they say, our next 10 years should be just like their past 10.

But the differences between Japan and the U.S. are huge. Japan's citizens save like champions, allowing it to finance its own misery internally. Not so here. The U.S. is dependant on the kindness of foreign strangers to finance its debt, a point that alone makes mimicking Japan's malaise far-fetched. I'm comfortable predicting that foreign creditors will bail on the U.S long before it has a chance to run debt near 200% of GDP, as Japan has. History bears this point out.

Speaking of issuing debt, here's Gross again:                                               

[L]ook at the behavior of the peddlers of the allegedly bubbly securities. During bubbles, when foolish investors are willing to place high valuations on companies in a hot sector, entrepreneurs and managers rush to give the public what they want. ... In a bond bubble, when borrowing costs are exceptionally low, you'd expect the government to increase its borrowing significantly, taking advantage of the idiots by issuing new bonds like crazy. But that's not happening. The federal government has actually borrowed less as bond yields have fallen -- much to the chagrin of liberal economists and progressives, who think the Obama administration is foolish not to borrow money at these insanely low rates and invest in high-speed rail, job creation, and infrastructure.

Not buying it. "Too little debt" isn't high on many sane people's list of government grievances.

In 2008 and 2009, the Treasury issued a net $1.2 trillion and $1.4 trillion in debt securities, respectively. Both are roughly three times larger than the previous record set in 2003. Some will always gripe that the government isn't doing enough. But when debt issuance triples previous records, it can't be accused of ignoring bond investors' insatiability, even if issuance has fallen in recent months.

And the Treasury is taking advantage of low interest rates in other ways. In early 2009, it released a memo saying it would favor issuing longer-dated securities as interest rates hit record lows -- an attempt to lock in rock-bottom rates for as long as possible. Sure enough, the average duration of Treasury debt is now 58 months, up from 48 months in 2008.

Then there are corporations. Junk bond issuance around the globe is at an all-time high -- odd given the state of the economy. High-quality companies from IBM (NYSE: IBM  ) to Johnson & Johnson (NYSE: JNJ  ) have been issuing piles of debt at negligible interest rates, yet corporations are almost universally sitting idle on their cash. Microsoft (Nasdaq: MSFT  ) went into debt for the first time ever last year. Why? Not because it needed the cash -- it's famously burdened with too much of the stuff. It was to take advantage of the idiots. Don't take my word for it. A Microsoft spokesman happily admits the deal was simply "taking advantage of good market conditions." Ahem.

For people who don't own calculators
Whether bonds are a bubble or not is just a silly exercise in semantics. What's important is whether they're a good deal or not. And when compared with available alternatives, namely high-quality large-cap stocks with high dividends, most are not. Today, you can buy a 10-year Treasury bond that yields 2.6%, or one of several high-quality stocks, including Altria Group (NYSE: MO  ) , Verizon (NYSE: VZ  ) , and Eli Lilly (NYSE: LLY  ) , that yield more than double that.

No one knows if bonds are a true bubble. But what seems likely, extremely likely, is that 10 years from now, those buying bonds won't be nearly as happy as those buying high-quality stocks. That's all you should care about.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Microsoft, Altria, Verizon, and Johnson & Johnson. Microsoft is a Motley Fool Inside Value selection. Johnson & Johnson is a Motley Fool Income Investor choice. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Altria Group. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

Read/Post Comments (20) | Recommend This Article (78)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 03, 2010, at 1:09 PM, ilovesumm wrote:

    Do the bond investors realize the market price for the bonds will drop the face value of their bonds?

  • Report this Comment On September 03, 2010, at 1:10 PM, TheDumbMoney wrote:

    If I could give this article six thumbs up I would.

  • Report this Comment On September 03, 2010, at 2:11 PM, fennecfoxen wrote:

    I'm all for buying stocks in general, but I'd rather not subject *everything* to the market, even in a good year. So for some of my money, the alternative isn't bonds: it's a 1.4% APY savings account.

    I'm running the risk that the bonds will keep me happier than a savings account will 5-10 years down the line, and that's an entirely different risk trade-off.

  • Report this Comment On September 03, 2010, at 5:20 PM, nbclark wrote:

    Bonds are not in a bubble because bubble assets tend to go down over 50%. For 10 yr. bonds to do that the interest rate would have to skyrocket. That would create other problems and the bond investor would still get his principle back unlike other bubble assets. Bonds may be a poor buy but they are not a bubble.

  • Report this Comment On September 03, 2010, at 5:32 PM, dc46and2 wrote:


    Where did you find a 1.4% APY savings account?

  • Report this Comment On September 03, 2010, at 5:40 PM, lazytype wrote:

    the value of bbubbled thing drops rapidly

    - real estate to dollars drops

    - stock to dollar drops

    - now bonds = dollars to other stuff will drop which is called inflation

  • Report this Comment On September 03, 2010, at 6:09 PM, cmfhousel wrote:


    "Bonds are not in a bubble because bubble assets tend to go down over 50%. For 10 yr. bonds to do that the interest rate would have to skyrocket. That would create other problems and the bond investor would still get his principle back unlike other bubble assets. Bonds may be a poor buy but they are not a bubble."

    I don't think bonds will fall 50%, but I can rephrase your argument to how someone might in 2005:

    "Real estate is not in a bubble because bubble assets tend to go down over 50%. For real estate prices to fall that much, major banks would go bankrupt. That would create other problems. And the real estate investors who wait 30 years, the length of their mortgages, will still probably see prices rise back to the level they purchased at."

  • Report this Comment On September 03, 2010, at 10:56 PM, lctycoon wrote:

    I may be a jerk, but I can't wait to laugh at all these people that think that government bonds are safe... especially a decade from now when interest alone forces tax rates up.

  • Report this Comment On September 04, 2010, at 12:14 PM, ATFing wrote:

    To DC43and2 I saw your post about the checking account and wanted to let you know my bank pays 2.75 and another in town pays 2.25 on checking accounts. There are conditions but they are easy to meet. 10 debits per month(no min), 1 ach, receive online statement , maximum balance $25,000 per account in first bank and $50,000 per account in second. My husband and I have had accounts since '04 and other than the rate started at 4.95% has progressively been reduced over the six years we are happy with both banks. The two banks are Progressive Savings Bank, and Cumberland County Bank, Both are in Crossville, Tn. Check them out if the conditions aren't too bothersome for you.

  • Report this Comment On September 04, 2010, at 12:19 PM, ATFing wrote:

    dc46and2 Sorry I posted your username 43. I wanted to add that you can have two accounts per bank if you and spouse each have one.

  • Report this Comment On September 04, 2010, at 2:48 PM, gman5556 wrote:

    We will see what happens when the Fed starts bringing interest rates back to where they need to be.

  • Report this Comment On September 05, 2010, at 12:37 AM, Deibster wrote:

    Eighteen months ago I bought Ford bonds at 80% of face value. They recently matured. I received full face value plus interest; I don't see how anyone can call that a bubble. I also paid less than par for GMAC bonds and par for tax-free government of Puerto Rico bonds. These mature in less than 10 years and are paying over 6% interst. You tell me, how is this a bubble when I'm receiving double the interest rate of other safe investments, and they'll likely mature before the interest rate hits 6%? Yes, I also have stocks paying 8 to 12% dividends with their value bouncing up & down every week. In brotherhood, deibster

  • Report this Comment On September 05, 2010, at 7:27 PM, ChrisBern wrote:

    (a) You can get 1.4% on a savings account from SallieMae (I signed up a few months ago)

    (b) I've never owned a bond in my life until about 6 months ago, and now I own several bond funds. While I agree with the author that holding bonds for the next decade would be foolhardy, that doesn't tell me much about the next 12 months. I fully expect bonds to outperform the S&P 500, dividends included, over the next 12 months.

    Reason: deflationary tendencies and the near-certainty that the Fed will keep short-term rates as low as possible. If and when equities become fairly priced again, or if it starts looking like inflation or interest rate increases are immiment, I'll dump my bonds and get back into equities. But for now, with the PE10 about 20% higher than historical averages, why would I buy into an overpriced S&P 500 against so many economic headwinds??

  • Report this Comment On September 06, 2010, at 10:48 AM, FutureMonkey wrote:

    Another fine article Morgan. Bonds are often viewed as the "safe" position providing capital protection while still providing a reasonable coupon return on investment.

    The bubble danger you are discussing is market risk (loss of price you can sell your asset) triggered by either mass migration out of bonds or rapid rise of interest rates (inflation risk or interest risk). Market risk for bonds is not a big issue if you are holding individual bonds and don't need to sell below par prior to maturity. The danger is in these publically traded ETF's and mutual funds that expose individual investors to market volatility. People think they are investing in bonds but they really are buying a market product that happens to invest in bonds. That product is subject to market risk. Thus, relative to a decent defensive stock with a dividend there may be little difference other than asset class. This can be avoided by laddering your own investment grade corporate, muni, or government bond issue with a coupon you are happy to hold to maturity. Buy at par and sit back and relax. Of course if you are panicking due to fear of stock market decline or participating in a mass rush into bonds, you might end up paying well above par to get into the bond.

    The other bond risk (that might trigger a mass migration) is inflation/interest risk. That risk that newly issued bonds offer a much higher coupon relative to what hold. Seems like a pretty likely scenario given the very low coupons being offered today. You and I don't know when inflation is going to happen (my guess is 7-10 years out), but you and I both know that WHEN it happens it is going to happen FAST! Most investors will be behind the curve. If you don't have liquidity and trade out of your low interest bond into a higher interest bond you will be exposing yourself to substantial market risk.

    Investors should be very familiar with bonds as well as stocks and need them in a balanced portfolio. TIPS seem like a decent conservative vehicle - not the best bond vehicle but a reasonable place to drip long money into that will provide happiness in the event of rapid return of inflation. Investment grad corporate bonds with short maturities is also a reasonable capital protection play. If you are in a top tax bracket then muni's are smart (but not without risk).

    The good news is that your portfolio doesn't need to be all or nothing - asset allocation models that keep you in equities (some foreign please), bonds, cash, and commodities seems to be a good idea.

  • Report this Comment On September 07, 2010, at 11:49 AM, rfaramir wrote:

    You're right to question Gross on this: "the least bad place to invest". I'm just not certain you know why.

    In most bad or uncertain times in the past, government bonds have been a safer place than most for your money. But in this case, the bad economic environment is CAUSED by government overspending and therefore over-issuance of bonds. Whenever the Fed "purchases" federal debt it INVENTS the dollars to do so. If you or I were to do this it would be called counterfeiting. Though legal for them to do this, it is still a scam, an immoral act, stealing the purchasing power of every dollar holder (or dollar-denominated assets like bonds).

    Economic problems caused by overspending and over-issuance of bonds to cover the spending CANNOT be fixed by spending more money that isn't theirs and issuing more bonds that our children will have to pay off. When the markets realize this (and there is no knowing when this will happen, so expect price deflation short term), the US will lose its triple A rating, the bond market will collapse, and the dollar will plummet.

    See and for more education on why government control of our money is a bad thing. Ending the Fed is the answer: book (, coin (

  • Report this Comment On September 07, 2010, at 12:55 PM, rfaramir wrote:

    To follow up, I didn't mean to sound so personally critical, Morgan (referencing my "I'm just not certain you know why").

    I mean to say you're on the right track, but I didn't see any clear evidence given for your correct position. So I tried to chime in to give some.

    In the first half you talk about how bubbles are not all the same, but I'd add that all bubbles are caused by money-creation and oversupply of credit. The resulting commodity 'bubble' is merely the effect, as all that new money chases somewhere solid to sink in and avoid the debasement.

    In the second half you are even closer to the truth when you write: 'Not buying it. "Too little debt" isn't high on many sane people's list of government grievances.' Too much debt is a huge problem, and their means of financing it (printing money) is disastrous.

    So, "good article, here's more ammo for you!" is more what I mean to say.

  • Report this Comment On September 07, 2010, at 2:40 PM, LesserofThree wrote:

    Whenever I talk to groups of investors I often discover that your average investor doesn't know a whole lot about convertible bonds, and that's ok. They know all about stocks, and they know all about bonds, but convertible bonds are a whole different beast.

    So what are convertible bonds? Well basically they are what we like to refer to as hybrid securities. They usually carry a fixed interest rate just like a bond but in the future you may be able to exchange them for a specific amount of common stock in the underlying company that has issued the bond. So you get the best of both worlds, the steady and reliable income that a bond produces, and the upside potential for growth that a stock allows for.

    Because that's the problem with bonds, there is no upside growth potential. A bond is a contract. You agree to lend the company a certain amount of money and in exchange they agree to pay it back with a certain amount of interest over a certain fixed period. If next year the company comes out with a brand-new earth shattering product and their stock shoots through the roof, you don't get any of that upside as a bond investor.


    Money without intelligence is like a car without a road.

  • Report this Comment On September 10, 2010, at 5:16 PM, TigerPack1 wrote:

    I don't always agree with your write-ups... But you appear half-way to getting religion on this issue, and I thank you for posting this article.

    When the fear and reality of Treasury downgrades returns, the bond bubble and ensuing inflation in 2011 will wipe out many "safe-haven" fortunes, and the bank accounts of little old lady, normal savers!

    Those of us doing the real math on the exploding U.S. sovereign debt problem, are freaking out. We are on a collision course with disaster, and few realize it... People like Warren Buffett, Charles Munger, George Soros, Jimmy Rogers, Alan Greenspan and many others see a day of reckoning fast approaching for the government, the markets and our economy. These people are not quacks, but honest, time-tested experts on how the markets work, and are being ignored by Washington pinheads.

    My personal feeling, that I have been screaming since late-2009, is the U.S. Treasury/FED bond ponzi scheme is quickly coming to an end, perhaps by late-2010.

    Here is more evidence out just in the last few weeks:

    1) Short-term interest rates are now HIGHER than 52-weeks ago, and a clear rising trend is now evident! The only way yields do not spike, is from direct FED buying of Treasuries... No wonder BEN decided to go deeper into the ponzi scheme a few weeks ago. As foreigners flee our sovereign debt mess, and U.S savers cannot fund the $60 billion "weekly" T-Bill funding needs, no one (barring the Federal Reserve game) exists to keep the scheme from unraveling. Treasury checks going out each week for Social Security, Medicare, military families, the unemployed, contractors, etc. REQUIRE direct FED game playing today in 2010, not in 2015, or some distant future date. We shuffle newly printed money into the financial system almost daily now. We are running out of time! Few advisers or investors want to face up to the situation, and gladly ignore the cancer festering out of control as long as they hold a job and the Dow rises daily.

    2) Long-term Treasury bond prices have fallen 7%-8% in 2-weeks, thereby wiping out 2 years of coupon yield for those brain-dead zombies purchasing a 30-year note that can NEVER be paid back in constant 2010 dollars.

    We have been boxed into quite a situation it now appears. We can choose recession and deficit reduction (like Europe is attempting) or do nothing to change course and face the threat of skyrocketing interest rates, ever greater money printing, debt downgrades, defaults and depression...

    I cannot think of another legitimate option presently besides... TAKE THE MEDICINE BEFORE IT IS TOO LATE! Raise taxes and slash government spending NOW.

    Once Humpty Dumpty falls he will NEVER be put back together again, EVER. We are on a dangerous course currently, that can only lead to real disaster, far greater than the 2007-2009 bust.

    I don't think the average Joe, our leaders in Washington, or the bozos on Wall Street completely appreciate the decisions we must make, and the pain we must now bear as a nation if we want America to survive and compete in the future.


  • Report this Comment On September 10, 2010, at 9:25 PM, hongchang wrote:

    your comparison of housing bubble to this so called "bond" bubble is absurd at the best and lack of common sense. The housing bubble was propelled by the reckless lending of banks to those who pays 0 or 5% down pays and betting housing would just go up 5% in short term so that they can double their down payment. If everyone had bought their house for living and intended to live in there for the rest of their life, there would not be any housing bubble. The later mentality is exactly what I see for the current bond buyers. They want to preserve their principle while they still can rack up a reasonable interest payment compared to 0% bank deposit. As for whether FED will raise interest substantically and make bond price crush, I don't see that's happening anytime soon given the current unemployement rate. Sorry, you don't have a case here.

  • Report this Comment On September 30, 2010, at 12:28 PM, njbrit wrote:

    Coming into this late, after a vacation, but -

    only futuremonkey has mentioned the fact that it doesn't matter if the price of the bond drops below face if you intend to hold to maturity. That's why the most common measure of a bond (after the credit rating) is the YTM - YIELD to MATURITY.

    I don't like bond funds - they are always chasing current yield, and sell far too often, so I buy individual bonds through Fidelity, although their markup is often high.

    I bought 2013 AIG, 2012 SLM, plus others, at 50 - 80 cents on the $. I sold $5000 face 7.125% Knight Ridder (cost $1858 in Jul '09), for $5025 in Feb '10 - annual yield of 288%. The SLM coupon 6.15% matures in 2021, and at purchase (61 cents on the $) had a YTM of 12%; currently @ 76 cents, I have an equity gain of 25%, a current yield of 8%, and if I sold now, an annualized profit of 33%. It's not ALL good - I had CIT bonds, and held my breath while they went through a re-org, but came out ahead. I will lose the $2050 (less the $450 in coupon payments) that I put into BlockBuster. Overall I spent $32,874 for $56,000 face bonds marked to mkt at $44,896, showing 37% increase, and an annualized profit of 33% (including the BB loss). The lesson is BUY QUALITY, BELOW PAR, and HOLD to maturity. Bubble or no bubble you WILL win, and you don't have to watch tickers, or pay sell commissions!

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