Bubble, Bubble, Toil and Trouble?


Rising bond prices are indicative of bond risk not safety, Wall Street Journal columnist Brett Arends writes in his article, “Bonds–Headed From Bull Market to Bubble?” He cites bond guru Bill Gross for the proposition that stocks are dead in terms of being suitable investments for long-term growth, and that bonds (historically considered safer than stocks) are in a bubble, and are, therefore, high risk.

Bonds yields have historically been the rate of inflation plus less than 2%. Today, the 10-year T-bill yields 1.8% and the 30-year T-bond yields 3% with no additional yield on top of that to keep up with inflation. Investment grade corporate bonds currently yield 3.5% on average.

Arends hints at an important consideration that investors face – time horizon. An investor’s time horizon is the time period during which the investor will not need to liquidate investments to meet a current expense, and can, therefore, ride out the troughs and avoid having to sell at a loss. A rule of thumb is that an investor should not put money that may be needed in 3 to 5 years in a risky investment like stocks.
That is because stock market gains and losses are not smooth or predictable. The stock market may be flat or down for a period of years (consider the “lost decade” of 2000 to 2010), then lurch forward making all its gains in a relatively short period of time.

Arends writes: “Investors these days are much wiser about stocks than they were in the 1990s. They know all that talk about big guaranteed returns was misleading because, historically, those returns came in waves. Stock investors made their money in the 1920s, in the 1950s and 1960s, and in the 1980s and 1990s. In other periods, they made very little. The period since 2000 has been one of those times.”

Arend’s point is that the same is true of bonds. “Waves come and go.” Currently, the bond wave is very high. It may go higher still. With Bernanke’s words to the effect that the Fed will keep rates low at least into 2015, the crest of the bond wave may not be near. But eventually the wave must crest. “Sooner or later investors will face either a loss of money, or at best meager returns.”

“Sometimes, the “best” option may just be the one that’s least bad,” writes Arends. But which option (or combination of options) is least bad: stocks that have doubled since March 2009, bonds with yields at record lows, or cash that returns nothing?

There is no single right or wrong answer. As always, investors and their financial advisors need to approach that dilemma with diligence and caution, considering the investors investment objectives, risk tolerance, time horizon and other factors.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.