Archive for the ‘Bubbles (Asset)’ Category

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Bonds Safe As Cash?

Friday, October 8th, 2010

I have written a few posts about the bond market bubble, with the most recent being the post of October 4 titled “Thoughts On The Bond Bubble.”

There are many aspects of the bond market that support the conclusion that it is in an enormous bubble.  I ran across the following from the SentimenTrader.com daily commentary of October 7 that I find notable.  It is further evidence that risks in the bond market are being ignored or not properly heeded.  Here is the commentary:

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Individual Investor Bond Allocation

The latest asset allocation survey from the American Association of Individual Investors (AAII) was just released, and it shows a continuation of an odd development.

Investors’ allocation to stocks was unchanged at 55%, but they increased their allocation once again to bonds, while sacrificing their cash cushion.

Their bond allocation jumped 4% to 25% of their total portfolio, while cash dropped 4% to 20%.

The odd thing about it is that historically, there has been a very positive correlation between investors’ allocations to bonds and cash.  Basically, it’s a “fear trade” – when they’re concerned, they pull money out of stocks and put it into bonds and cash.  When they’re confident, they pull money out of bonds and cash and put it into stocks.

But not lately.  Over the past year and a half, the correlation has completely broken down, and investors are now using the bond market as their safe haven.  When they reduce stock exposure, they put it into bonds, and not cash.

Yes, the interest rate on cash is nearly nil.  But it was also extremely low during periods prior to 2010, and yet the AAII folks still didn’t consider bonds to be the only safe haven.

The thing that’s a little disturbing is that by using the bond market as a default safe haven, investors neglect to remember that long-term bonds do carry the risk of losing one’s capital unless held to maturity, which can be a very long ways off.

Looking at the other sentiment indicators on the Bond page of the site, we can see a smattering of other extremes, like sentiment surveys and the positioning of traders in bond futures.  Put/call ratios are exceptionally low, but they have been an inconsistent predicator of future market performance.  Rydex traders have seemingly given up trying to time that market.

The chart above is very long-term, and it may be nothing to be concerned about.  It just struck me as unusual – and not positive for bonds – that it now seems to be considered as safe as cash.”

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A Special Note concerning our economic situation is found here

SPX at 1159.99 as this post is written

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Thoughts On The Bond Bubble

Monday, October 4th, 2010

Lately there has been much commentary on whether the bond market is in a bubble.  While many believe such a bubble exists, others – including many prominent investors and commentators – disagree.

As I have previously written, I believe that there is a bond bubble encompassing the entire bond market.  While for many reasons one might not expect the bond market to become a bubble, nonetheless such a bubble has occurred and it is now simply enormous.  This bond market bubble stands out from other bubbles in history in both size and duration.

As one can see in the chart below, from Doug Short’s site on 10-4-10, the 10-Year Treasury Yield (blue line) has been on decline since the early ’80s:

click on chart to enlarge image

This decline in bond yields has been exceedingly munificent to the economy in many different ways.  As well, the bond bubble has been very beneficial to a range of asset classes.   On the above chart, one can see the performance of the S&P500 in green during this period of falling interest rates.

Of course, if one believes the bond market is a bubble, then a pivotal question becomes when will the bubble “pop?”  This question is difficult to answer, as there is a complex interaction between various factors fueling this bubble.

One important factor is that of additional Quantitative Easing (QE).  Many believe that such efforts will further depress interest rates.  Various estimates seem to generally support the idea that $2 Trillion of additional QE would depress 10-Year Treasury rates (currently at 2.48%) by approximately 100 basis points.  While I believe that such an effect may be possible, it is likely such an impact is overstated.

For many reasons, it is tempting to conclude that the bond bubble will last for years.  In fact, I am not aware of anyone who is predicting its imminent demise, i.e. “popping.”  However, I believe, from an “all things considered” basis, that the “popping” of the bond market will happen in the short-term (i.e. likely within 6 months, and possibly even yet in 2010).  I make this judgment based upon many different factors.  Such a bursting of the bond bubble will have immense ramifications on many levels; I have already discussed the threat of rising interest rates in an April 6 post.

Another critical issue with regard to the bond bubble is the following:  If one believes that there is a bond bubble that is serving to unduly depress interest rates, what might be the “natural” interest rate – i.e. one that may endure after the bond bubble pops?  I may discuss this, as well as further define the timing of the bond market “top”, in future posts…

A Special Note concerning our economic situation is found here

SPX at 1137.03 as this post is written

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The Importance Of Asset Bubbles

Monday, September 13th, 2010

“When you live in a bubble, everyone is delusional…” -

-Nouriel Roubini, May 11 2010 Charlie Rose interview

Many people fail to see any asset bubbles in our current economic environment.  Others see isolated asset bubbles.  As I have previously stated in the April 8 post,  “Our societal inability to spot and prevent asset bubbles is problematical.”

I have written extensively about the existence of asset bubbles.  The topic is of critical importance as their widespread existence precludes the possibility of Sustainable Prosperity.

A Special Note concerning our economic situation is found here

SPX at 1109.55 as this post is written

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Identifying The Housing Bubble

Thursday, August 19th, 2010

The Boston Federal Reserve recently came out with a report dated August 12 titled “Reasonable People Did Disagree:  Optimism and Pessimism About the U.S. Housing Market Before the Crash.” (pdf)

A sentence from the abstract is particularly interesting: “We conclude by arguing that economic theory provides little guidance as to what
should be the “correct” level of asset prices —including housing prices.”

My comments:

This is the latest effort from The Federal Reserve which questions whether asset bubbles,  in this case the Housing Bubble, can be accurately identified as they form.

While one may argue as to whether economic theory can accurately spot asset bubbles, there definitely is a chronic need to do so – as well as to take proper remedial action.  As I wrote in an April 8 post, “Our societal inability to spot and prevent asset bubbles is problematical.”  We simply can’t afford to go through numerous asset bubble booms and busts.   This issue is especially critical now given that there are numerous large asset bubbles currently in existence on a global basis.

A Special Note concerning our economic situation is found here

SPX at 1079.47 as this post is written

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The Corporate Bond Bubble

Wednesday, August 18th, 2010

On August 13 The Wall Street Journal had an article titled “J&J Sets a Yield Low.”

From the story: “The health-care products firm sold 10-year bonds with an interest rate of 2.95%, or a risk premium of 0.43 percentage point over comparable Treasurys.”

The story provides an overview of the strong market environment for both corporate and junk bonds.

My view is that the entire corporate bond market is in a bubble.  This bubble is related to the bubble in U.S. Treasuries which I have previously commented upon.

A Special Note concerning our economic situation is found here

SPX at 1092.54 as this post is written

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The Bond Bubble

Friday, June 11th, 2010

On June 8 The Wall Street Journal had an article titled “Bond-Fund Managers See Signs of a Bubble.”

While most people wouldn’t think of the bond market as having bubble characteristics, nonetheless such a bubble has developed.

The article mentions several vulnerabilities the bond bubble faces.  I would add that a major vulnerability is a repricing of risk due to perceived asset quality, due to a variety of issues.

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SPX at 1086.84 as this post is written

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“From Bubble To Bubble To Bubble”

Friday, May 28th, 2010

I ran across the following weekly S&P500 chart and comment from Maurice Walker, of thechartpatterntrader.com at StockCharts.com.  Although I do not necessarily agree with all of the chart’s annotations and the accompanying commentary, I definitely think that both are worthy of contemplation:

chart courtesy of StockCharts.com

(one can click on the chart to enlarge the image)

Maurice Walker’s accompanying comment:

“The Keynesian Cure Never Works

The US had a massive malinestment (An investment in wrong lines which leads to capital losses. Malinvestment results from the inability of investors to foresee correctly, at the time of investment) in housing induced by affordable housing mandates, easy money from the Fed, and Fannie and Freddie guaranteeing mortgages that they had no business guaranteeing.

You cannot get over a debt infused recession with more debt. You have to work off the malinvestment. This is why the Keynesian cure never works. Just look at Greece.

But instead of working off the malivestment, we are trying reinflate the housing bubble with more spending. We are trying to reinflate the economic bubble with the stimulus package.

The Fed has to keep pressing the accelerator faster and faster to main tain the same simulative effect. But if the keep doing this it will cause inflation to arise. Additionally, the Fed already engineered a runaway expansion of the monetary base, that will generate explosive inflation. The borrowing needs of Obama’s record-shattering deficits will only exacerbate the effect. We are moving from a housing bubble to a government debt bubble that is going to ultimately collapse the dollar.”

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SPX at 1092.58 as this post is written

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“Bubble Investing”

Thursday, May 27th, 2010

I recently saw an ad for “Bubble Investing” and thought it was notable.  It used to be that the mere idea of an asset bubble led to concern.  Now, it appears as if asset bubbles are seen by many as more of an opportunity than a threat.

Of course, investing in bubbles can be profitable.  As I wrote in the December 3, 2009 post, “Investing in bubbles can be extremely profitable on the way up; however, for the “long” investor they can produce huge losses if one doesn’t time the exit appropriately.”  History has shown that the (vast) majority of investors don’t time the exit appropriately.

While I have extensively written of how problematical the asset bubble situation is today, it should be noted that others have written to the contrary.   The April 25 2010 post concerning work by Frederic Mishkin and an April 27 article by James Picerno are two prominent examples.

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SPX at 1085.04 as this post is written

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Two Quotes From Alan Greenspan

Monday, April 26th, 2010

As an extension of the last post concerning bubbles, here are two of Alan Greenspan’s past comments that I find particularly relevant given our current environment:

This is from a September 26, 2005 speech he gave in which he speaks about how negative “shocks” may impact the economy.  I find this quote interesting as it is an example of, among other things, how one can overlook the severity of embedded risks in a bubble environment:

“How significant and disruptive such adjustments turn out to be is an open question. Nonetheless, as I have pointed out in previous commentary, their economic effect will, to a large extent, depend on the flexibility inherent in our economy. In a highly flexible economy, such as the United States, shocks should be largely absorbed by changes in prices, interest rates, and exchange rates, rather than by wrenching declines in output and employment, a more likely outcome in a less flexible economy.”

This next quote is from his “The Crisis” paper, p. 45:

“‘…history has not dealt kindly with the aftermath of protracted periods of low risk premiums.’”

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SPX at 1217.28 as this post is written

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Mishkin’s Previous Comments On Bubbles

Sunday, April 25th, 2010

On April 8 I commented upon William C. Dudley’s “Asset Bubbles” speech.

In that speech, he refers to Frederic Mishkin’s speech of May 15, 2008.  It should also be noted that Mishkin offered similar thoughts in a Financial Times op-ed of November 9, 2009.

There is much I can comment about in each of Mishkin’s commentaries about bubbles.  For now, I will limit myself to the following:

Here is a passage from the aforementioned 2008 speech which I found most interesting:

“…monetary policy should not try to prick possible asset price bubbles, even when they are of the variety that can contribute to financial instability. Just as doctors take the Hippocratic oath to do no harm, central banks should recognize that trying to prick asset price bubbles using monetary policy is likely to do more harm than good. Instead, monetary policy should react to asset price bubbles by looking to the effects of asset prices on employment and inflation, then adjusting policy as required to achieve maximum sustainable employment and price stability. This monetary policy response should prove sufficient to prevent adverse macroeconomic effects of some types of asset price bubbles.”

I interpret this (and other points in his speech) as (in effect) saying that monetary policy shouldn’t be used to prevent bubbles, but it should be used to “clean up the mess” should they “pop.”

This “mindset” seems to be prevalent now among policy makers.

I believe this overall “treatment” of bubbles is frightfully perilous, has already created immense damage, and will end very badly.

It appears as if not only are we (as a nation) downplaying the risks of bubbles, but also are continually unable to identify their existence.

As I wrote on March 29: “I strongly disagree with those who think that bursting bubbles are not something to be unduly concerned about….While it may be pleasant to ignore the existence of bubbles, and downplay the potential significance of their bursting, I believe that the existence and prevalence of bubbles in today’s worldwide economy is perhaps the largest threat to achieving Sustainable Prosperity.”

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SPX at 1217.28 as this post is written

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