The Bond Bubble That Isn’t

After experiencing two major asset bubbles in the last 15 years, we find ourselves on constant bubble alert. The Sherlock Holmes in each of us is inspired to investigate which major asset class is set to experience the next spectacular fall. What common investment is so ridiculously overpriced that only a fool would dedicate even a dollar to it?

To me, it seems that more fingers point to US treasury bonds than to any other asset. Intermediate and long-term treasury yields of 2-3% are close to their lowest levels in decades. You can get a 2-3 % long-term return in these investments….if you are lucky. No asset class wears its valuation on its sleeve in quite the same way. It tapes its own “kick me” sign on its back and almost begs investors to seek higher returns elsewhere.

Investors tend to take heed. Why invest in treasury bonds when their yields are so low and the Federal Reserve is now raising interest rates? Aren’t higher interest rates a bond-killer? This is certainly a bubble that is soon to burst and we are smacked in the face with this very obvious conclusion.

I simply disagree with it.

Bubbles in assets occur when investors think it reasonable to invest every last dollar in that asset. They are the object of everyone’s affection, not their disdain. These assets are perceived to be high speed trains about to leave the station. Investors must all get on board before it’s too late. To sell such a precious asset would be unthinkable. Are treasury bonds in that category right now? It seems that it is quite the opposite.

When the Federal Reserve raises interest rates, they are only raising short-term rates. This is all they have control over. Intermediate and long-term treasuries represent the market’s perception of what interest rates will look like over 5-10 years out. This is not dictated by the Federal Reserve, but rather by the market’s view of future economic strength and inflation. If the market feels that the Fed raising short-term interest rates will cause long-term economic weakness (and possibly deflation), then long-term interest rates may go down as a result and treasury bonds may rally.

For now, treasury bonds are still a good “anti-risk” asset. They often benefit when investors are concerned about the state of the world economy. They can go higher when all of our other investments are getting routed. Treasuries are useful to a portfolio’s allocation.

I acknowledge that the returns made on intermediate and long-term treasuries will be limited over the next 5-10 years. I’m not backing up the truck or loading the boat with treasuries. However, I still use them to diversify portfolios and they still help.

Will treasuries be in a bubble one day? Possibly so. If it happens, it will likely be during the next crisis when investors feel that intermediate and long-term treasuries are the only asset worth putting their money into. In my opinion, we are nowhere near that point now.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is no guarantee of future results.