EconomicGreenfield

In previous posts I have discussed the Bond Bubble and its many facets.  In particular, I would like to highlight my post of October 4 2010, “Thoughts On The Bond Bubble.”

During the recent market tumult, bond yields have once again dropped sharply to very low levels, as seen by the yield on the 10-Year Treasury.  A couple of charts illustrate this.  First, a weekly long-term chart from 1962 as seen in Doug Short’s August 12 blog post titled “Treasury Yields in Perspective“, with 10-Year Treasury Yields shown in blue:

(click on chart to enlarge image)

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Next, a 3-year daily chart of the 10-Year Treasury Yield:

(click on chart to enlarge image)(chart courtesy of StockCharts.com)

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While this Bond Bubble may have a little more “upside” left to it, I am of the belief that attempting to derive gains from bonds at this point is akin to “picking up pennies in front of a steamroller” – i.e. there is little to be gained, and much to be lost.

While the Bond Bubble continues, its risks to investors, financial markets and the economy in general has in no way diminished.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 1194.20 as this post is written

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