Is This a Bond Bubble?
August 16, 2010 2:55 PM
As the new decade began, Minyanville Founder Todd Harrison wrote The Decade of Decadence and visually walked through the bubbles and busts that littered the last 10 years. As we cast our eyes ahead to a potentially similar situation, we must consider what makes a bubble.
The first is price versus intrinsic value. In stocks that can be measured by P/Es and in housing by prices versus incomes, and normally one would measure this in terms of spreads versus Treasuries.
(To read Josh Lipton's take on how you can make money off of wheat, click here.)
But currently the Treasury market -- and the short-term Fed Funds and mortgage markets for that matter -- are being "managed" by the Fed's aggressive monetary policy.
This makes it very difficult for investors (particularly retail investors) to determine what intrinsic value really is. (See also The Fed Declares War on America.)
Put simply, people are looking at the spread versus Treasuries without considering whether Treasuries are appropriately priced in the first place. In many ways, this reminds me of late 1999 when people measured PEs for a particular stock versus a 25 PE for the overall market; nobody questioned whether a PE of 25 made any sense in the first place.
The issue is further compounded by the psychological issues associated with earning "nothing.” And as retail investor bond ladders mature, people are losing a 4%-5% yield and looking to replace it. They can't accept 50 or 80 basis points as a "reasonable" return and the choice becomes whether to stretch in terms of maturity or credit risk, or both. (For more on investor psychology, see Taking Stock of the Stock Market.)
(To read Kevin Depew's list of the Top 10 IPOs in history, click here.)
And to me this is why junk bonds are screaming right now. They are the only thing that "works."
Folks also forget that what defines a bubble is the use of proceeds and whether the funds are being used in an efficient or productive manner. Here I have two thoughts.
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