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Bond Bubble? Maybe Not. The "Lower and Longer" Argument

Is there a bond bubble? Maybe. Treasury yields are near record lows. The iShares iBoxx High Yield Corporate Bond (NYSEMKT: HYG  ) ETF yields 6.4%. There's little room for error. The big returns of the past are now almost certainly a thing of the past.

But the word "bubble" can be dangerous. It implies an imminent pop, which is never a sure thing. Investors thought Japanese bonds were in a bubble in the early 1990s. Twenty years later, interest rates are still stuck to the floor.

Last week I asked Charles Schwab chief investment strategist Liz Ann Sonders what she thought of the bond bubble talk. Here's what she had to say (transcript follows):

Sonders: The view from our fixed-income group has been lower for longer. Yes, you are probably well past the major, major tailwind of a 30-year decline in inflation and interest rates, but that doesn't necessarily mean it looks like a V on the upside, as long as we have the Fed in the position that it's in, which is not only keeping rates low on the short end, but buying on the long end and very little reason in the very near term why they should stop that.

And the fact that we've got still a very wide output gap; we have very little velocity of money. We don't have any upward pressure on wages. Those are the types of things you would tend to see kick in first before inflation took hold, which would be the condition under which rates would start to go up, probably more rapidly than what's built into expectations.

That said, in general, we're past probably the low, and that fixed-income investors need to be at least mindful of that, and there are certain things they can do within the fixed-income portion of their portfolio, which is a few steps shy of running for the hills because of some view that rates are going to spike from here.

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  • Report this Comment On April 19, 2013, at 12:21 PM, SkepikI wrote:

    Ah, you well know rates don't have to spike for investors to start running. Surprised to not see you make that point. But maybe that comes later in the commentary. All it will take to press Bonds down 10% in value is the realization that Good equities yield 3% or more and investors are missing out, risking value drops in bonds and the pain registering at last. Then look out!

    There are still those who think they are trading return for safety, and so 1 or 2 or 3% yield with zero upside and scary downside risk looks ok for now. It wont take much more IMO to wake them up....sooner rather than later, just like gold a mini bubble burst will panic the herd.

    Even 5,6,7% return couldn't begin to cover the downside risk of bonds right now.

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