On Market Manias – Bond Edition

It’s time to come out and say it. The bond market action – driven by Fed policy and a steady flow of discouraging economic news, and helped by “flash crashes” and stories of HFT and stock market manipulation – has reached a ridiculous stage. This morning yields are falling again on more bad data (durable goods is the pensee mauvaise du jour), with the 10 year Treasury note punching down through the 2.5% level.

It’s not unique or original to say the bond market is a bubble, those assertions are all over the blogosphere. I continue to believe the bond market itself is a very sober and thoughtful segment of the financial system, or as Ritholtz calls it, “adult supervision.” At this point, however, it’s reasonably clear that too many investors are piling in. That’s what bubbles are made of.

ICI data on fund flows shows continuing movement out of stocks and into bonds. For some perspective, consider that an investor can buy IBM common stock that yields ~2%, or IBM three year notes yielding 1%. For those who choose the bond, the obvious conclusion is that they think they would have a capital loss in the shares at the end of three years.

Is the fear justified? Perhaps. The economic data really is pretty awful. My personal opinion is that the pessimism is overdone.  That does not mean, however, that I am going to be a hero and buy more stocks now because they are cheap. They can, and very likely will, become cheaper still. That is the deflationary mentality that has taken hold across much of the economy.

For those of us who have seen market manias before – tech stocks in the 90s, real estate in the 00s, energy in 2008 – it is clear that a silly mania can go a lot longer, and a lot further, than any of us could guess.

The takeaways: (1) don’t buy bonds, they are hugely overpriced except for certain lower grade corporate issues (2) don’t short bonds, even though they are absurdly overbought, until we get a clear signal on the charts. You could get seriously hurt doing either of these. The thing to do, if you must have bonds, is buy TIPS, otherwise just stay out of the way and wait for the wreck to happen.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s